Thursday, September 06, 2007

Bank of Canada announces to hold "lending rate steady"

Bank of Canada announces to hold "lending rate steady"
Some economists expect no change at all in 2007

The Bank of Canada probably won't raise interest rates until December at the earliest, and possibly later, economists said yesterday after the central bank left its benchmark rate unchanged, warning troubles in the United States and global credit markets could bite into Canada's economic growth.

The Bank of Canada not only kept its key overnight rate at 4.5 per cent, but also dropped from its announcement an earlier signal that rates may need to rise to fight inflation. The overnight lending rate is the Bank of Canada's main policy tool, which in turn influences consumer lending rates, and the central bank said it deemed the current level appropriate.

Some economists now believe the Bank of Canada will hold rates steady for the rest of the year, and almost certainly at its next setting on Oct. 16. At least one economist still sees the central bank cutting rates by one-quarter of a percentage point in mid-October.

Developments in the United States and in troubled global credit markets will determine what happens after that, including at a Dec. 4 setting.

The central bank painted a robust picture, saying the Canadian economy appears to be operating more above its production potential than earlier estimated, and citing a strong labour market and higher home sales and prices than expected.

But it pointed to the troubles in the U.S. housing sector and the uncertainty surrounding the depth and length of the current credit crunch.

"It now seems likely that the adjustment in the U.S. residential housing sector will be more pronounced and protracted, exacerbated by recent developments in financial markets," the central bank said, adding this implied weaker demand for Canadian exports than it had anticipated in July.

"I think the conditions right now, and in the past, are quite rosy," Beata Caranci, TD Bank Financial Group's director of economic forecasting, said in an interview, but central banks, economists and markets are having trouble evaluating the economic fallout, if any, from the credit crunch that began with the crisis in U.S. subprime mortgages and spread to other credit markets.

Indeed, the Bank of Canada said that while household spending could be stronger than expected, "recent developments in financial markets have led to some tightening of credit conditions for Canadian borrowers, which should temper growth in domestic demand."

The central bank still cited the fact that inflation in Canada remains above its target but, as Caranci wrote in a research note, did not "show undue concern" about inflation.

BMO Capital Markets senior economist Sal Guatieri said the central bank is now "solidly on the sidelines ... but it will act fairly quickly if the risks of a weaker economy or higher inflation play out."

While many economists see the Bank of Canada simply holding the line for the rest of the year, Ted Carmichael, chief Canadian economist for JPMorgan Chase, believes the central bank will cut rates by one-quarter of a point in mid-October.

Many economists believe the U.S. Federal Reserve Board will cut rates at its next setting Sept. 18, or even earlier, and Carmichael expects the Canadian central bank to follow a month later, seeing U.S. economic growth is going to be weaker, with some fallout in Canada.

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