Bank of Canada holds rate steady but acknowledges weak economy

Bank of Canada holds rate steady but acknowledges weak economy

HEATHER SCOFFIELD Globe and Mail Update

June 10, 2008 at 9:12 AM EDT

OTTAWA - The Bank of Canada is holding its key interest rate steady, even though it acknowledges the economy has stagnated and could well weaken further.

The central bank announced Tuesday it is putting an end to its aggressive streak of rate cuts because soaring commodity prices have prompted a fresh fear of inflationary pressure.

"Although the composition of U.S. growth has not been favourable for demand for Canadian goods and services, overall, global growth has been stronger and commodity prices have been sharply higher than expected," the bank said in a statement.

"The balance of risks to the bank's April projection for inflation in Canada has shifted slightly to the upside."

The bank's decision maintains the overnight rate at 3 per cent, and shows how much thinking about the global economy has shifted in the past few weeks to focus on the pain consumers feel at the pumps.

Bank of Canada Governor Mark Carney has said in the past that he expected commodity prices to fall because global demand was weakening. That projection has proven wrong, as oil has skyrocketed to close on Monday at more than $134 (U.S.) a barrel.

Economists and market players had widely been expecting a small rate cut of a quarter of a percentage point to stimulate the economy as it deals with recessionary conditions in the United States as well as tighter credit conditions.

But economists had also said that the central bank could quite easily justify a more aggressive rate cut to confront a slowdown in Canada, or swing the other way and freeze rates in the face of rising commodity prices.

The Bank of Canada has cut rates by a total of 150 basis points since late last year, attempting to stimulate the economy as it deals with a rapid slowdown in demand from buyers in the United States.

Indeed, the bank's statement recognized that Canada's gross domestic product contracted slightly in the first quarter. The economy is now in a state of slack, and is expected to slacken further this year.

Growth should pick up later in 2008, and accelerate into 2009 as the U.S. economy recovers and as past interest rate cuts in Canada begin to have an effect, the bank said. Still, there is a risk that growth will be weaker than expected.

Clearly, however, the bank's first preoccupation is inflation, and not sagging growth.

"If current levels of energy prices persist, total [consumer price] inflation will rise about 3 per cent later this year," the bank warned.

Core inflation, which excludes volatile prices such as energy and some food, will remain below the bank's 2 per cent target, however, throughout this year and next.

The bank said it had already done enough to boost growth in Canada, saying "the current stance of monetary policy is appropriately accommodative."

Economists have pointed out that inflationary pressure in Canada is relatively benign, giving the central bank room to cut rates if it chooses.

In April, total inflation was running at a 1.7 per cent annual pace, while core inflation was 1.5 per cent - both well below the central bank's target.

"Canada's relatively muted inflation performance gives the bank the luxury of pondering further rate cuts if need be," said Douglas Porter, deputy chief economist at BMO Nesbitt Burns, in a note to clients Tuesday.

"We think a cut is justified on the fundamentals in Canada - cool core inflation that will likely remain so, and weak GDP figures that sill leave behind a fumbling economy," said economists at Bank of Nova Scotia Tuesday.

But central bankers around the world are warning about rising inflationary pressure, as they watch commodity and food prices soar, hurting consumers. The European Central Bank has suggested its next move could be an interest rate hike because of inflation. The U.S. Federal Reserve has hinted that its rate cuts have come to an end.

And on Monday, the head of the Bank of France pointed out that central bankers have a tough job in deciding monetary policy these days, as rising commodity prices compete with slowing growth.

"Today we may be at the start of a cycle in the world economy where there is less growth and more inflationary pressures," Christian Noyer said in an interview. "That is more difficult for central bankers to deal with than in the past, when inflationary pressures were lower."