BoC ups growth, stands pat on rates

OTTAWA — The Bank of Canada boosted its growth forecast Tuesday but threw a curve ball at Bay Street expectations for a July interest-rate hike by warning the “persistent strength” in the loonie could cause even greater headwinds for the economy.

While some analysts still expect the central bank to start raising rates in July after leaving them unchanged on Tuesday at 1%, others said the statement indicated the bank is in no hurry and could wait until the fall at the earliest.

“It will be difficult to pin down when the next hike will be when you have a central bank that takes the currency into account when making its policy decision,” said Avery Shenfeld, chief economist at CIBC World Markets. “And we have a currency that’s volatile right now.”

Mr. Shenfeld said the central bank would prefer a “softer currency” before it opts to raise rates again. He added that could unfold in July, if commodity prices take a breather.

That is what happened Tuesday as commodities — and the loonie — slumped on global growth fears. The currency ended the day at US$1.0383, down US0.72¢.

As expected, Bank of Canada governor Mark Carney and his colleagues boosted the outlook for 2011 real gross domestic product expansion by a half percentage point, to 2.9% from 2.4%, while paring back growth in 2012, to 2.6% from 2.8%. With the improved outlook, it said economic slack would be absorbed more quickly than expected, with the economy reaching full potential by mid-2012.

Inflation is expected concurrently to converge to the bank’s preferred 2% target.

The central bank is expected to go into more depth about its slightly rosier outlook when it releases its quarterly economic outlook on Wednesday.

But the improved economic outlook comes with a caveat: a heightened warning about the Canadian dollar. The currency is trading near a three-year high, and could prove to be a drag on net exports – which is now a key driver of GDP growth, along with business investment, as household indebtedness and rising energy prices keeps consumers at bay.

“The persistent strength of the Canadian dollar could create even greater headwinds for the Canadian economy, putting additional downward pressure on inflation through weaker-than-expected net exports and larger declines in import prices,” the Bank of Canada said.

Analysts and fund managers interpreted the bank statement in different ways.

One camp believes the upgrade in GDP growth coupled with a quickly narrowing output gap suggests the central bank is gearing toward a hike in July.

“They are more bullish,” said Denis Senécal, vice-president of fixed-income and cash for State Street Global Advisors Canada, adding increases in the policy rate could begin in July.

Notwithstanding comments about the Canadian dollar, the bank is “more upbeat and positive about the Canadian economy.”

Mr. Senécal said what’s holding the central bank back is clarity as to how and when the Federal Reserve ends its US$600-billion asset purchase plan, which has exerted downward pressure on the U.S. currency — prompting traders to go elsewhere, like Canadian assets, for yield and driving the loonie upward.

Others, however, said the central bank’s concern about the loonie points to a rate hike no earlier than the fall – and maybe beyond.

The statement “suggests the strong potential for policy neutrality for some time,” said analysts at Scotia Capital.

They said the central bank “aggressively and explicitly trumpeted” the risks posed by loonie compared to previous rate decisions, signaling it is worried about the impact on export growth – a concern Scotia Capital shares.

Trade data released Tuesday indicated Canada’s trade surplus narrowed significantly from roughly $400-million to $33-million on sharp declines in exports and imports. This result suggests that the central bank’s “concerns about lost competitiveness [among Canadian companies] stemming from poor productivity growth and an elevated Canadian dollar are vindicated,” Scotia Capital said.

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