Tuesday, June 10, 2008

Bank of Canada Leaves Key Interest Rate Unchanged

The Bank of Canada on Tuesday defied expectations and left its key interest rate on hold at 3%, despite concerns over a weakening economy here and a downturn in the United States.

Although the composition of U.S. growth has not been favorable for demand for Canadian goods and services, overall, global growth has been stronger and commodity prices have been sharply higher than expected.

At the same time, many of the downside risks to inflation ... have eased, while the evolution of credit conditions has been in line with expectations. The risk remains that potential growth will be weaker than assumed.

Most economists had forecast the 25-basis-point rate cut, pointing to disappointing economic growth - and despite a risk of higher inflation from soaring global energy and food prices.

If current levels of energy prices persist, total CPI inflation will rise above 3% later this year. However, with the Canadian economy operating in excess supply, core inflation is expected to remain below 2% through 2009. Both total and core inflation should converge on 2% in 2010 as the economy returns to balance.

Against this backdrop, the bank now judges that the current stance of monetary policy is appropriately accommodative to bring aggregate demand and supply into balance and to achieve the two per cent inflation target. There continue to be important downside and upside risks to inflation in Canada, which the bank will monitor closely.

The bank's decision could be bad news for consumers and businesses.

Traditionally, commercial banks follow the central bank's lead with matching cuts to their benchmark prime rates, now at 4.75%, to which floating-rate consumer and business loans, including mortgages, are linked.

The Canadian dollar remained relatively unchanged after the rate decision. It closed Monday at a two-month low of 97.89 US.

The bank's surprise move indicates the central bank has ended it cycle of rate leave.

The much more focused concern about the upside risks to inflation suggest that the bank is done cutting rates. This is quite an abrupt turn from the last decision date, when the bank declared that 'further monetary stimulus would likely be required'.

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