Carney May `Keep the Powder Dry' and Hold Canada's Rate at 3%

By Greg Quinn

Sept. 3 (Bloomberg) -- The Bank of Canada will likely keep borrowing costs unchanged today as inflation stays above its upper limit, and may express greater concern about an economy that just missed contracting for a second straight quarter.

Governor Mark Carney and his five deputies will leave the target rate on overnight loans between commercial banks at 3 percent for a third straight meeting, according to 27 of 28 economists surveyed by Bloomberg.

Carney and his counterparts from the Group of Seven industrialized nations are struggling to sustain growth as high energy costs fuel inflation and curb demand. Canada's economy grew at a 0.3 percent annualized pace in the second quarter, avoiding what most economists would have dubbed the first recession since 1991. Inflation quickened to 3.4 percent in July, outside the bank's 1 percent to 3 percent target.

``Inflation has to start coming down,'' said Michael Gregory, senior economist at BMO Capital Markets in Toronto. ``Until you get a sense of how things are playing out, the best strategy is to keep the powder dry.''

Still, today's statement may include stronger language that highlights the risks to growth. Deputy Governor David Longworth said Aug. 26 that growth and inflation this year will both be slower than expected in July, when policy makers said they saw ``balanced'' risks.

The decision in Ottawa is scheduled for 9 a.m. New York time. The bank may cut rates in the first quarter of next year, according to the weighted average of eight economists surveyed by Bloomberg.

`Downside' Risk?

``Instead of saying the risks are balanced, they could say `roughly balanced with a risk to the downside,''' said Eric Lascelles, chief economist with TD Securities Inc. in Toronto. Should the bank move rates this year, before most economists expect, Lascelles said it's more likely to be a reduction than an increase, because ``the Canadian economy is going slowly.''

There's little sign slumping exports to the U.S. will rebound. Sales to Canada's main trading partner were behind Carney's assertion in July that the economy will grow just 1 percent this year, the slowest since 1992.

The U.S. economy grew at a 0.2 percent annualized pace in the second quarter excluding trade, indicating there's been little growth in American domestic demand as that country recovers from the subprime mortgage meltdown.

Canada's total shipments abroad fell 1.5 percent in the second quarter, the fourth straight three-month period that saw a decline. Exporters were also hurt by the Canadian dollar's appreciation to a record last year.

Ontario `Challenges'

``We are still in a fairly good economy, but we're seeing some slowdown,'' Luc Vanneste, chief financial officer at Bank of Nova Scotia, Canada's third-biggest lender, said in an interview in Toronto. Vanneste cited ``challenges in Ontario,'' Canada's biggest province and factory heartland.

Canadian factories laid off 32,300 people in July, mostly in Ontario, where the struggling automotive industry is based. Total Canadian employment fell by a net 55,200 workers, the biggest decline in 17 years.

The layoffs, coupled with high gasoline prices, are crimping the spending Carney and Conservative Party Prime Minister Stephen Harper need to sustain growth.

Harper, 49, may call elections this week because he says Canada's minority-led Parliament isn't working. Liberal Party Leader Stephane Dion, head of the biggest opposition bloc, says Harper wants a vote now to try and win a fresh mandate before the economy worsens.

Household Spending

Already, growth in spending by households slowed for a second straight quarter from April to June to 0.6 percent on lower car and truck purchases, Statistics Canada said Aug. 29.

Rona Inc., Canada's biggest home-improvement retailer, said Aug. 12 that profit dropped for the third straight quarter as consumers reined in spending on renovation projects.

``The Bank of Canada is accepting the fact that growth is going to be pretty awful,'' BMO's Gregory said.

To be sure, slow growth doesn't change the bank's mandate of keeping inflation at 2 percent as often as possible and always between 1 percent and 3 percent. July's rate was the fastest since 2003, and the central bank says inflation will peak at 4.3 percent in the first quarter of 2009 before returning to 2 percent later that year.

Retail gasoline prices though have waned from a peak of C$1.39 ($1.30) per liter in mid-July to C$1.28 last week. Crude oil fell to a five-month low yesterday as energy firms prepared to resume production after Hurricane Gustav caused less damage than anticipated.

Inflation could slow faster than forecast, such as in 2003 when energy pushed the rate above 4 percent and it slowed to the bank's target within six months.

To contact the reporter on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net.