UPDATE 3-Bank of Canada softens stance, rate hike still on horizon

Wed Mar 6, 2013 12:05pm EST

Related Topics

* Central bank holds rate at 1.0 percent as expected

* Says rate hikes still likely but after "a period of time"

* Inflation weaker than expected; continued slack in economy

By Louise Egan and Randall Palmer

OTTAWA, March 6 (Reuters) - The Bank of Canada softened its stance on the need for interest rate hikes on Wednesday, saying it will likely hold its benchmark rate steady for "a period of time," but that its next move would still probably be a hike rather than a cut.

The central bank held its overnight lending target unchanged at 1.0 percent, where it has been since September 2010. It had been signaling for several months that it intends to raise the rate, but in January said such a move was "less imminent" and on Wednesday it took another step back.

"With continued slack in the Canadian economy, the muted outlook for inflation, and the more constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required, consistent with achieving the 2 percent inflation target," the bank said.

Its previous guidance did not include a reference to "continued slack" or to the "period of time" over which rates would likely stay on hold.

The Bank of Canada is alone among central banks of the Group of Seven leading industrialized nations to have a tightening bias.

But it is watering down that bias following the weakest six months of growth since the 2008-09 recession, which meant the Canadian economy underperformed the U.S. economy for the first time in seven years.

Central bank chief Mark Carney expects the economy to regain momentum through 2013, but Wednesday's figures offered evidence instead of continued weakness. The pace of purchasing activity in Canada slowed in February for the second straight month, according to Ivey Purchasing Managers Index data.

The seasonally adjusted index fell to 51.1 from 58.9 in January. Analysts polled by Reuters had expected a reading of 57.5.

Global forecasters in a Reuters poll published on Feb. 27 pushed back expectations for the bank's next rate hike to the first quarter of 2014 from the fourth quarter of 2013 previously.

Ahead of Wednesday's announcement, some market players had even braced for a complete removal of any mention of rate hikes in the future.

But most received what they had expected - a more nuanced nod to a disappointing economic performance that pushed any monetary tightening far off into the horizon, but still put indebted consumers on notice that borrowing costs can only go up.

"They went more dovish on the details, signaling more spare capacity and generally more subdued inflationary pressures," said Derek Holt, economist at Scotiabank.

"To me, that just says the Bank of Canada is playing the pause, which is in line with our forecast that the bank is on hold through all of this year and next and they are going to fight the rate cut camp pretty forcefully going forward."

The Canadian dollar weakened to a session low against the U.S. dollar immediately after the rate statement.

At 12 noon (1700 GMT), the currency was at C$1.0313 to the greenback, or 96.96 U.S cents, compared with C$1.0288 just before the central bank announcement and $1.0280 at Tuesday's North American close.

Traders slightly increased bets of a rate cut later this year, according to yields on overnight index swaps which trade based on expectations for the policy rate.

Inflation has been weaker than the bank anticipated but it still sees both core and total inflation returning to its 2 percent target by the end of 2014. Low core inflation was "consistent with material excess capacity."

The central bank's language on the housing market and household debt were also similar, with a projection that residential investment will decline further from historical highs and the household debt-to-income ratio will stabilize near current levels.

The bank played down the economy's humdrum growth in the fourth quarter of 0.6 percent annualized, noting "solid growth across most domestic components of gross domestic product," which was offset by a sharp drawdown in inventories.

Its broad outlook for the Canadian economy was unchanged from January. It believes growth will gain momentum through 2013 with the help of modest household spending and a recovery of business investment and exports.

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