Bank of Canada Keeps Key Interest Rate at 1%

This article appeared on on July 19th, 2011.

The Bank of Canada has kept its bench-mark overnight interest rate steady at one per cent, saying the need to keep the country’s economy growing amid the U.S. and European debt crises outweighs the need to slam the brakes on inflation.

In response to the central bank’s decision, the Canadian dollar has gained more than a cent in morning trading.

The Bank of Canada said Tuesday that Canada faces an uncertain international economic situation with European and U.S. debt concerns dominating the fiscal landscape.

“The U.S. economy has grown at a slower pace than expected and continues to be restrained by the consolidation of household balance sheets and slow growth in employment,” the bank said in a press release.

“While growth in core Europe has been stronger than expected, necessary fiscal austerity measures in a number of countries will restrain growth over the projection horizon.”

Thus, while Canada is growing roughly as the central bank had forecast, the country still faces a threat to its slowly-recovering export sales, partly because of weak U.S. economic growth and partly because of a rising Canadian currency.

Tuesday’s rate decision provided further lift for the Canadian loonie. The currency traded at $1.053 US in mid-morning, up from Monday’s Bank of Canada close of $1.043 US.

Growth versus inflation

Economists had split as to whether the bank would raise its overnight borrowing rate or keep the trend-setting interest rate at its current, record-low level as the July decision approached.

Late last year, Bank of Canada governor Mark Carney talked extensively about the need for Canadians to rein in their personal debt levels, a signal many experts interpreted as the central banker about to get tough on rising prices.

Indeed, many economists began predicting that the bank would boost rates in July, especially after three months — March, April and May — when inflation popped above the central bank’s one-to-three-per-cent target range for price growth.

Carney, however, began signaling a change of sentiment in June when he talked about the financial “headwinds” Canada faced in an interview with the Wall Street Journal.

His wording lead to a subtle shift in thinking among Carney watchers.

“The hard place that Carney is caught between is the growing risk that Canada’s economy will underperform expectations if U.S. demand remains weak and/or Europe’s credit crisis erupts and spews lava across global financial markets,” said BMO Capital Markets economist Sal Guatieri in a commentary prior to Tuesday’s rate announcement.

Economic growth — something central bankers are trained to generally ignore — began pushing out concerns over rising prices in the bank’s thinking, experts said.

Still, many economists believe the Bank of Canada will boost interest rates towards the end of 2011 as long as the Canadian economy keeps to its current decent GDP growth path.

RBC Economics, for example, currently predicts that Canada’s economy will grow at a 3.2 per cent clip in 2011, equal to the growth rate for 2010.
Europe and America

There are growing fears that the Greek debt crisis is spreading to other European countries, especially the continent’s third biggest economy — Italy.

As well, the administration of U.S. President Barack Obama has so far failed to reach a deal with the U.S. Congress over whether to raise Washington’s borrowing ceiling.

Failure to get an agreement by Aug. 2 risks placing the world’s largest economy in technical default of it debt obligations.

Both situations hold the potential to drive the global economy back into a recession similar to the one in 2008-09 or at least to reduce the potential economic growth for most countries, experts have warned.
Into the winter

Still, the Bank of Canada said it is eyeing rate hikes into the later months of 2011.

“To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn,” the Bank’s statement said.

The central bank now forecasts that Canada will expand by 2.8 per cent in 2011 and 2.6 per cent in 2012, the year that the Bank expects the Canadian economy will reach full capacity.