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Bank of Canada Hold Key Rate

Best be getting used to this: Mark Carney, governor of the Bank of Canada, has again maintained interest rates at 1% and remains on track to not budge from that position any time soon as upside and downside risks remain balanced amid moderating growth.

This marks the 11th straight time the central bank has held rates at the 1% level, since a 25 basis point increase in September 2010. Since 2000, the bank has employed eight fixed dates a year when it makes decisions on the key rate. Economists expect the bank to keep interest rates at current levels until as late as next year.

The bank’s statement contained a few contradictions: It says the last quarter was stronger than expected, but growth in the future will moderate. Yet the economy will return to capacity quicker than expected.

Huh? Here are the main takeaways from the bank’s statement:

Canada muddles through, more or less

The overall outlook for the Canadian economy remains “little changed” from the bank’s October monetary policy report, with “more momentum than anticipated in the second half of 2011,” but comments Tuesday show a mixed picture with growth “expected to be more modest than previously envisaged.”

On the one hand, the bank has pushed up the schedule for the economy to return to full capacity by one quarter, to the third of 2013, and projects growth of 2.0% in 2012 and 2.8% in 2013 based off 2.4% growth last year. “While the economy appears to be operating with less slack than previously assumed, given the more modest growth profile, the economy is only anticipated to return to full capacity by the third quarter of 2013, one quarter earlier than was expected in October,” he said.

On the other hand, Mr. Carney expects the pace of growth to be more modest than previously thought, largely due to outside factors. “Prolonged uncertainty about the global economic and financial environment is likely to dampen the rate of growth of business investment … Net exports are expected to contribute little to growth, reflecting moderate foreign demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar,” he said. Of note, the loonie spiked to a two-week high against the greenback earlier Tuesday.

Household debt still a problem

“Very favourable financing conditions are expected to buttress consumer spending and housing activity,” he said. “Household expenditures are expected to remain high relative to GDP and the ratio of household debt to income is projected to rise further.” The Bank of Canada has been harping on this for a while, but the conditions created by the lengthy low interest rate environment have led Canadians to borrow and spend. Debt-to-income ratios have hit repeated record highs in the past few years, and the trend is expected to continue.

If not hawkish, at least less dovish

The outlook for inflation remains stable for now, with dynamics similar to those in October, but Mr. Carney characterized the inflation profile as “marginally firmer.” Inflation is expected to slow in 2012, before rising again to 2% in the third quarter of 2013 as excess supply is absorbed, wages grow modestly and expectations remain anchored. “Several significant upside and downside risks are present in the inflation outlook for Canada. Overall, the bank judges that these risks are roughly balanced over the projection horizon,” he said.

Europe: Still a big mess

“The sovereign debt crisis in Europe has intensified, conditions in international financial markets have tightened and risk aversion has risen,” Mr. Carney said. “The bank continues to assume that European authorities will implement sufficient measures to contain the crisis, although this assumption is clearly subject to downside risks.” Children, of course, already know the schoolyard rhyme about what happens to “U and Me” when you assume anything.

The rest of the world: Not much better

“The outlook for the global economy has deteriorated and uncertainty has increased,” the bank said. In the United States, while the GDP rebound in the second half of the year was a welcome surprise, the bank remains bearish on the pace of growth in 2012 due to household deleveraging, fiscal consolidation and spillover from Europe. Chinese growth is also slowing as expected, to a more sustainable pace. Commodity prices, except oil, are expected to be below levels forecasted last October at least through to 2013.

Financial Post

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