12/06/2011 09:35 EST

Bank Of Canada Leaves Interest Rate Unchanged, Warns Of Shocks To Come


OTTAWA - The Bank of Canada is keeping interest rates at ultra-low levels for a while longer, warning that the economy is facing a series of shocks from around the world that will dampen growth and keep inflation in check.

The central bank's decision to keep the benchmark overnight rate — which helps determine short-term interest rates in the private banking sector — at one per cent was not a surprise. Many economists expect it will be there for another year or so.

If there was something new in the one-page statement issued by the bank alongside its early morning policy announcement Tuesday, it is that bank governor Mark Carney thinks the risks from around the world may be intensifying.

The bank said it now expects the recession in Europe "to be more pronounced," a downgrade from October when it said the continent would go through a brief slump.

While economic activity in the U.S. has been more robust than anticipated, the spillover effects of Europe and the country's own internal problems will weigh on growth going forward. As for China and emerging nations that have been the mainstays of the global economy over the past few years, all signs point to the pace of expansion "moderating."

"The weaker external outlook is expected to dampen GDP (gross domestic product) in Canada through financial, confidence and trade channels," the bank said.

"The economy also continues to face competitiveness challenges, including persistent strength of the Canadian dollar.... Reflecting all of these factors, the bank has decided to maintain the target for the overnight rate at one per cent."

The bank views its current policy setting as helping stimulate economic growth in Canada by keeping the cost of borrowing for both businesses and households low, thus encouraging investments and spending.

Some economists have called on the bank to lean on the rate further, to as low as 0.25 per cent, but there were no signals in the statement that Carney is thinking along those lines.

The bank said it is not worried about inflation at the moment. While at 2.9 per cent it is higher than the two per cent target the bank strives for, it expects weaker economic activity and moderating energy and food prices will bring overall inflation in line.

But Carney has often expressed concerns that his low interest rate policy, in place for about three years, is encouraging irresponsible behaviour among households, particularly overspending in the housing market.

As the bank noted in October, the Canadian economy is doing slightly better during the current second half of 2011 than was previously anticipated. GDP in the third quarter was one point higher than the bank's two per cent call, and analysts believe the same adjustment will be made to the bank's 0.8 per cent growth prediction for the fourth quarter.

The better performance, the bank said, has been due to stronger than expected household spending and continued healthy business investment. But exports have also so far defied the worsening global trends, recording solid gains in the third quarter.

The stronger second half will likely result in 2011 overall growth higher than the predicted 2.1 per cent, but the bank gave no guidance on its milder 1.9 forecast for 2012.