Bank of Canada signals rates to remain on hold

The Bank of Canada kept its key policy rate at 1 per cent on March 6th 2013. It has been unchanged at this level for more than two years, marking the longest period since the early 1950s that rates have been left untouched.

Many economists had expected the Bank to soften its language amid a spate of disappointing economic news in recent weeks; however, Governor Carney has cautioned against over-emphasizing shorter-term data, and today's announcement echoed that view by addressing recent weak readings in a number of indicators as "recent volatility".

While the Bank did maintain its previous guidance that the next move will likely be a rate hike, one way in which the Bank did take a more dovish stance was by way of what it did not say this time, namely the warning it issued in January that higher rates might be required if consumers continued to accumulate debt.

This was an indication that the Bank is becoming more comfortable with consumer debt and the housing market. The Bank referred to recent developments in the housing sector as "constructive", and reiterated its expectation that household credit growth would continue to moderate, with the household debt-to-income ratio stabilizing near current levels.

Despite the weak, though largely expected reading for Canadian economic growth in the fourth quarter of 2012, the Bank said it still expects Canadian economic growth to pick up through 2013 driven by "solid business investment" and "a recovery in exports".

The Bank said its expectations for overall fiscal drag coming from the U.S. over the next two years were largely unchanged, although it is now likely to be more front-loaded owing to sequestration spending cuts. This, combined with the weak handoff for growth from late 2012 into 2013, could mean a downgrade to the Bank's current forecast for growth of 2 per cent this year; however that forecast will not be revisited until the Bank's next Monetary Policy Report slated for release on April 17th.

Inflation has recently been lower than previously expected, and is expected to remain subdued in the months ahead before gradually rising to reach the 2 per cent target "over the projection horizon", which would be sometime in 2014.

All that said the bottom line remains unchanged, namely that economic growth is expected to remain modest but positive, consistent with low inflation and low interest rates. Growth in household debt burdens, which the Bank has repeatedly flagged as a major risk in this low interest rate environment, continues to show positive signs of topping out as housing market activity continues to stabilize at a more sustainable levels.

At the same time, expectations for inflation remain extremely well anchored, so the Bank will be in no hurry to raise interest rates anytime soon. At this point, the first such policy move not likely until 2014 at the earliest, and even that assumes that some of the more recent developments are simply a temporary soft patch, which remains to be seen.

As of March 6th, 2013, the advertised five-year lending rate stood at 5.24 per cent. It has been unchanged at this level since the beginning of June 2012.

(CREA 03/06/2013)