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Bank of Canada Holds Rates Steady

The Bank of Canada sharply downgraded its expectations Wednesday on economic growth for the first half of this year, but held the line on offering more stimulus because it says it still believes better times are just around the corner. As anticipated, the central bank kept the trendsetting policy rate at one per cent while chopping its growth forecast for 2013 by half a point to 1.5 per cent. The economy was expected to speed up next year and in 2015 to 2.8 and 2.7 per cent growth respectively, but the slow start means that the economy won't return to full capacity until mid-2015 -- six months later the previously predicted.
Some economists had urged the bank to back away from its tightening bias that still points to higher rates in the future as a way to further depress the dollar and boost exports to foreign markets, but the bank stuck to its guns. Appearing at what is likely his last full news conference in Canada before departing for London, governor Mark Carney -- flanked by his likely successor Tiff Macklem -- explained they were not buying into the doom and gloom. "We need to go back to the context," Carney said. "Interest rates are at one per cent, we have a financial sector as resilient as any in the world, there is slack in the economy, but it's not that big and it's not that big, relative to other major economies."

Macklem elaborated that the bank is counting on strong economic growth in the United States to eventually lift Canada as well, in terms of boosting exports of lumber and other housing-related products, as well as energy. In turn, that should convince Canadian businesses, including those in the oil patch, it's time to start investing for the future. "Why do we think growth is going to pick up?" he asked. "We are seeing a pick up in private demand in the United States -- you are not going to see it as much in the headline numbers because there's a fairly large fiscal contraction, but the private demand is positive for our exports. There's some strengthening in emerging markets, and then with some delay, a pick up in (business) investment. So the table is set."

The two say the weakness will be temporary. Following a stall in the latter half of 2012, the economy will only grow 1.5 per cent in the first quarter of 2013 and 1.8 in the second. But after that, they see it expanding by 2.3 in the third and 2.8 in the fourth. For 2014, the expansion continues with an average 2.8 bounce before tapering off to 2.7 in 2015.

That is still too rosy for many economists, although the 1.5 prediction for this year puts the bank below the 1.6 per cent consensus used by Finance Minister Jim Flaherty in last month's budget.
Carney said another reason for keeping the guidance in place is to discourage irresponsible borrowing from households who already are at record levels of debt. The bank says the bias, along with other measures, has been effective in cooling Canada's hot housing market and credit growth. However, it also cautioned that there were "still signs of overbuilding" in the condo market of some cities, and that prices in some segments remain "stretched."

Scotiabank economist Derek Holt said the bottom line is that Canadians likely won't be hit with higher interest rates until 2015. The tell-tale sign, he said, is that the bank pushed back the closure of the output gap to mid-2015. "That's a very strong signal that they are not in hike mode until at least 2015, and even then, it's not as if you get worried about inflation pressures instantly once you close off spare capacity -- you need to get the economy into material excess demand and that can happen well after that," Holt said.

Although the bank is adamantly opposed at the moment, David Madani of Capital Economics believes the incoming Bank of Canada governor may be looking toward cutting interest rates further, if the promised growth spurt does not materialize. That won't happen on Carney's watch. The next policy announcement date is May 29, two days before he departs for the Bank of England, and there is little chance of the policy team changing its mind over such a short period unless there's a global crisis.