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Bank of canada holds rate as trade drags

OTTAWA — The Bank of Canada said Tuesday economic activity has weakened due to a poor trade performance that could “dampen” the anticipated recovery in net exports, prompting it to keep its key policy unchanged at 1%.

In its most recent forecast, the central bank said it expected net exports and business investment to power the economy as overstretched consumers pared back spending. But only one of those factors — capital spending by firms — is holding up in the present environment.

“This underlines a previously identified risk that a combination of disappointing productivity performance and persistent strength in the Canadian dollar could dampen the expected recovery of net exports,” the central bank said in its statement explaining its latest rate move.

The decision was largely expected, given heightened tensions in financial markets from Europe’s debt woes and a string of tepid economic data.

As a result, keeping the policy rate unchanged “leaves considerable money stimulus in place, consistent with achieving the 2% inflation target in an environment of significant excess supply,” the central bank said, reiterating that any further rate increase would need to be “carefully considered.”

The Canadian dollar, which had been trading near parity with its U.S. counterpart ahead of the rate statement, lost ground once the central bank decision was released. Bond yields, however, were up slightly, as traders increased their risk appetite on news that the Bush-era tax cuts would be extended for at least two years.

The statement was a “pretty clear signal of the Bank of Canada’s intent to remain on pause for the foreseeable future,” said Michael Woolfolk, managing director at BNY Mellon Global Markets.

“With the bank concerned now about the economy’s increasing reliance on net exports and recent weakness in net exports amidst ongoing currency strength, it will take particular care not to unnecessarily bolster the loonie via higher rates.”

The Bank of Canada’s decision Tuesday morning followed a move hours earlier by Australia’s central bank to keep its benchmark rate unchanged, citing heightened risks in Europe and an expected slowdown in job creation over the coming year.

A series of mixed-to-disappointing domestic economic data were released over the past week just as the Bank of Canada, led by governor Mark Carney, contemplated its next move. Among the key economic indicators to emerge: meagre third-quarter growth of 1% annualized, below central bank expectations for a 1.6% advance; a job gain of 15,200 in November, although the headline figure masked overall market sluggishness as full-time and private-sector positions fell; and a bigger-than-expected fall in the value of building permits.

Tuesday’s statement was shorter than the previous Oct. 19 decision — at which time it scaled back growth expectations — and tried to recap recent economic developments by pointing out negative and positive developments. Central bank watchers were keen to see if the rate statement would nix market expectations, based on trading in fixed-income markets, for a rate hike in either March or April of next year.

Commenting on recent third-quarter data, Bank of Canada said household spending was stronger than anticipated and growth in business investment — which Mr. Carney had repeatedly said was crucial to the recovery — was “robust.”

However, net exports proved to be a “significant drag,” shaving 3.4 percentage points off the headline GDP figure. It also contributed to Canada posting a record current-account deficit, equivalent to roughly 4% of GDP, in the July-to-September period.

Higher-than-expected inflation readings for October — 2.4% headline and 1.8% core — had people wondering if this would force the central bank’s hand in terms of rates, given the Bank of Canada’s mandate to keep inflation at 2%. The statement, however, said inflation dynamics “have been broadly in line” with expectations, and underlying pressures remain “largely unchanged.”

“The tone of the statement was defensive and had enough of a tint of pessimism to validate the decision,” said Andrew Pyle, wealth advisor and markets commentator at ScotiaMcLeod. “The bank sees the export factor as an offset to what is still a very favourable domestic demand recovery in Canada. But, the real concern is clearly what is happening across the pond with respect to sovereign debt.”

The central bank said the global economic recovery “is proceeding largely as expected, although risks have increased. As anticipated, private domestic demand in the United States is picking up slowly, while growth in emerging market economies has begun to ease to a more sustainable, but still robust, pace.”

At least one prominent U.S. economist predicted big things for the American economy now that the uncertainty over the Bush-era tax cuts looks to be settled.

“Instead of another year expanding at no more than the U.S. economy’s potential growth rate — with job gains of 1.2 million and unemployment hovering near 10% — real GDP growth will accelerate to 4%, job gains will pick up to 2.8 million, and the unemployment rate will decline to around 8.5% by year’s end,” said Mark Zandi, chief economist at Moody’s Analytics.

While data from Europe suggest a modest recovery is underway on that continent, “there is an increased risk that sovereign debt concerns in several countries could trigger renewed strains in global financial markets,” the central bank statement said.

This is the final Bank of Canada rate statement for the 2010 calendar year. The next decision comes on Jan. 18, followed shortly after by an updated economic forecast. The central bank projected 3% growth in Canada this year and 2.3% in 2011.

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