Bank of Canada Leaves Rates Unchanged

Daily Forex Fundamentals | Written by RBC Financial Group | Jul 15 08 14:11 GMT |


The Bank of Canada met market expectations and kept the overnight rate steady at 3% indicating that "the risks to its base-case projection for inflation as balanced." The statement indicated that surprises since the April Monetary Policy Report have been largely on the side of inflation with the CPI now expected to move above, albeit temporarily, 4%. On the growth side developments have largely been in line with their views expressed in April. There seems to be little concern about the recent deterioration in financial markets with the Bank even indicating that they expect growth to move above potential by "early next year."

The Bank's statement focused on three main areas - "protracted weakness in the U.S. economy; ongoing turbulence in global financial markets; and sharp increases in many commodity prices." While the statement indicated that the first two factors are evolving in line with the Bank's forecasts, the unprecedented rise in commodity prices has raised the upside risks to inflation while keeping Canada's terms of trade improvement intact and supporting income growth. The Bank downgraded forecasts for growth in 2008 to 1.0% from 1.4% but was optimistic that the combination of accommodative monetary policy, the terms of trade boost and a "gradual " recovery in the US economy will see Canada's growth rate rise to above-potential early next year. 2009's growth forecast was forecast at 2.3% (small downward revision from April's 2.4%) with the economy expected to grow 3.3% in 2010.

More importantly, the Bank upped their forecasts for headline inflation and said that the rate will remain higher for longer than in the April forecast. The updated projection said that Canada's headline inflation rate may "rise temporarily above 4 per cent, peaking in the first quarter of 2009" if the energy prices follow pricing in the current forward curves. The core measure however "is projected to remain well contained and broadly in line with earlier expectations, averaging close to 1.5 per cent through the third quarter of this year and then rising to 2 per cent in the second half of 2009." The forecast for the second half of 2009 was revised up from April's 1.8%.

Based on these forecast updates, the Bank now gauges the risks to the "base-case projection for inflation as balanced."

The Bank's upgrade to the inflation forecasts put some meat on the bones of their June statement that the "balance of risks to the Bank's April projection for inflation in Canada has shifted slightly to the upside" with the biggest surprise being that the Bank raised the prospect that the headline inflation rate could rise to 4% in the near term and will remain above target into next year. Despite the somewhat hotter inflation environment, forecasts that the economy will grow at a slower than potential rate this year (and we think that downside risks to the economy mounting given renewed financial market turbulence), suggests that the Bank is likely to hold the policy rate at 3%.

RBC Financial Group
http://www.rbc.com