BUSINESS

Bank Of Canada Warns Of Disinflation, Loonie Dives

01/22/2014 11:36 EST | Updated 01/25/2014 04:01 EST
CP

UPDATE: The Canadian dollar pulled back nearly a full cent after the Bank of Canada's decision to keep its key interest rate steady while lowering its forecast for inflation.

The loonie dropped 0.95 of a cent to settle at 90.19 cents U.S. on Wednesday afternoon.

Original story follows

TORONTO — The Canadian dollar pulled back more than half a cent following the Bank of Canada's decision to keep its key interest rate steady, but lower its forecast for inflation.

The loonie dropped 0.58 of a cent to 90.56 cents U.S. shortly after the rate decision was announced.

The central bank said inflation has been lower than expected and won't return to its ideal target until 2016 — and that's even though the domestic economy has shown signs of improvement.

Both competition in the retail industry and a lack of significant economic growth were cited as two reasons the central bank believes inflation will remain below targets.

The commentary added pressure to the Canadian currency, which has already lost more than three cents U.S. since the end of 2013.

Disappointing trade and employment data has coupled with pressure from the U.S. dollar which has risen as the U.S. Federal Reserve starts to cut back on its key stimulus measure, the massive monthly bond purchases that have kept long term rates low.

"As expected, the statement retains a broadly dovish flavour, although the bias as before remains broadly balanced between a possible rate reduction and potential increase,'' said CIBC economist Peter Buchanan in a note.

The Bank of Canada expects the total inflation rate to remain at 0.9 per cent in the first half of 2014, down from its previous forecast of 1.2 per cent, but should "increase very gradually'' and reach the bank's ideal target of 2.0 per cent in last quarter of 2015.

Canada's economic growth in the second half of 2013 was better than expected and should pick up from an estimated 1.8 per cent last year to 2.5 per cent in both 2014 and 2015, it said.

Stronger demand in the United States as well as the lower loonie should help boost exports, which will also improve business confidence and investment.

The currency has lost nearly four cents since Dec. 31, when it closed at 94.02 cents US, due to a combination of factors including a strengthening U.S. dollar, weak prices for commodities and Canada's low-interest, low-inflation environment.

"Despite depreciating in recent months, the Canadian dollar remains strong and will continue to pose competitiveness challenges for Canada's non-commodity exports,'' the bank said in its report.

That was the key phrase, said BMO chief economist Doug Porter.

"This is a strong statement for the Bank, and as close as they will come to saying the currency is still overvalued and, thus, further depreciation is welcome,'' he wrote in a note.

Porter also noted that the emphasis the potential for inflation to be too low was "ramped up at notch'' in the bank's latest statement.

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