03/08/2012 09:06 EST | Updated 05/08/2012 05:12 EDT

Bank Of Canada Interest Rate Stays At 1 Per Cent


OTTAWA - The Bank of Canada is getting a little more optimistic about the domestic and global economies, although growth is far from strong enough for the central bank to start raising interest rates.

As widely predicted, bank governor Mark Carney and his policy-setting team kept the trendsetting overnight interest rate at the highly stimulative rate of one per cent for the 12th consecutive date on Thursday.

The Bank of Canada had been widely expected to start raising the rate last summer but those hikes didn't materialize — primarily because of a slowdown in North American economic growth and concerns about the European debt crisis.

But the central bank's more upbeat tone Thursday cheered markets. The loonie rose almost half a cent shortly after the 9 a.m. release of the bank statement to 100.66 cents US.

"This is a very sharp change from January," said Scotiabank economist Derek Holt. "They are acknowledging that, oops there's isn't as much slack in the economy."

Holt said the bank statement might imply that Canadian interest rates will move sooner than expected, but added there are plenty of reasons to believe that is not the case. He remains convinced there will be no interest rate hike in Canada until the third quarter of 2013.

"If this were a normal cycle, they probably would be hiking now," Holt said. "But given so much of the outlook is ... things that could go moderately OK or horribly wrong all of a sudden, they want to keep their powder dry."

Analysts said there are several reasons to expect the bank to stay moored to their one-per-cent rate, even though the latest statement highlights concern about household debt and higher than expected inflation pressures, both factors exacerbated by a low interest rate environment.

Raising rates could lift the loonie higher, which would make global and U.S. markets for Canadian exporters even tougher to crack. As well, Carney's U.S. counterpart, Ben Bernanke, has issued a conditional commitment not to touch rates in the U.S. until 2014.

As well, despite the rosier statement, the central bank continues to underscore that the global and Canadian economies are far from out of the woods. Global growth remains below trend, China is slowing, oil prices are elevated, and Canadian household debt remains a concern.

Higher interest rates would increase the cost of borrowing and many observers, including Carney and Finance Minister Jim Flaherty, have said they're worried that many Canadian consumers are ill-prepared for rates to go up.

CIBC chief economist Avery Shenfeld adds that while the U.S. economy has improved, 2013 looks to be a tough year south of the border given that markets expect the U.S. federal government will withdraw stimulus.

"We still see risks that North American growth stays muted in 2013 as U.S. fiscal tightening kicks in, and therefore see a longer wait for any start to rate hikes," Shenfeld said.

But the key reason, said Holt, is that monetary policy is the wrong tool to accomplish what Carney wants — rein in borrowing and cool house prices — because the side effect would be to strengthen the dollar and weaken the economy. Carney would look tor Flaherty to tighten mortgage rules if borrowing does not moderate, he said.

Overall, the Bank of Canada sees the world in slightly brighter colours than it did in January when it warned of global conditions deteriorating and risks rising.

"The heightened uncertainty around the global economic outlook has decreased in the weeks since (January) ... with tentative signs of stabilization in European bank funding and sovereign debt markets," it said in an unusually fulsome statement.

Canada too has seen conditions brighten somewhat, the bank predicting the economy is growing faster in the first three months of this year than in its previous call for a 1.8 per cent advance.

The revision comes after Statistics Canada last week upgraded third-quarter growth to a robust 4.2 per cent — seven-tenths higher than previously reported — and calculated December's hand-off to the new year was relatively strong.

But risks remain, Carney cautioned. Besides slow global growth, add elevated oil prices driven by Middle East political instability.

"If sustained, (oil prices) could ultimately dampen the improvement in global economic momentum," he warned.

For Canada, Carney said the No. 1 risk continues to be household debt, which currently stands at a record 153 per cent of disposable annual income.

Some economists had expected the revisions might push the Bank of Canada to revise its call for the economy to return to normal by two or three quarters to the beginning of 2013, but the policy team made no mention of when the output gap would be closed, although it cited "reduced economic slack."

Instead, the central bank said it believes much of the improvement in Canada has been of a temporary nature, suggesting it hasn't changed its mind that economic growth in 2012 will continue to slow to about two per cent, from last year's 2.5 per cent gain.

"Although the economy will likely grow faster than forecast in the first quarter due to temporary factors, underlying economic momentum remains around trend, balancing domestic strength and external weakness," the bank reported.

Still, it said private demand is expected to be slightly stronger, consumer spending will remain high as households add to their debt burdens and net exports will be stronger too, if still modest.

The bank said inflation will likely be higher this year as well, averaging about two per cent.