* Bank of Canada holds overnight rate at 1.0 percent
* Says risks of low inflation appear to have increased
* More dovish language hits C$; market pricing in small
chance of cut
* BoC continues to predict soft landing in housing market
By Louise Egan and Randall Palmer
OTTAWA, Dec 4 The Bank of Canada held its
overnight interest rate steady on Wednesday, but sounded a touch
more dovish in its outlook, saying the risks of undesirably weak
inflation appeared greater than they did six weeks ago.
The change in tone knocked the Canadian dollar to
its weakest level in three years. Traders slightly increased
bets on the possibility of a rate cut in late 2014, though they
are still pricing in less than a 25 percent chance of this
The central bank stunned markets in October by abandoning 18
months of signaling that rate hikes were on the horizon. But it
made clear at the time it was just as likely to raise rates as
to lower them as it was caught between excessive household debt
on one hand and below-target inflation on the other.
The bank's statement on Wednesday showed it was now
increasingly concerned about possible disinflation after the
inflation rate dropped to 0.7 percent in October. It added,
however, that the balance of risks remained within the range of
possible scenarios it had identified in October.
"The risks associated with elevated household imbalances
have not materially changed, while the downside risks to
inflation appear to be greater," it said.
Royal Bank of Canada Assistant Chief Economist Paul Ferley
said the surprising emphasis on the downside risks to inflation
would weigh on the Canadian dollar.
"I thought there would be a bit more balance in terms of
indications of growth coming in stronger than expected," he
said, adding that Royal still sees the central bank holding
rates steady through 2014.
The Canadian dollar weakened after the statement to
C$1.0695 to the U.S. dollar by 10:51 a.m. EST (1551 GMT) from
C$1.0662 just before the statement.
The bank has kept its overnight rate target at 1 percent
since September 2010, following three successive hikes that year
as Canada pulled out of a relatively mild recession.
None of 32 analysts polled by Reuters last week had expected
any rate move on Wednesday, but many market players were
nonetheless bracing for the possibility that the bank would
somehow introduce more dovish language without signaling actual
The median forecast in that poll was for the bank to start
raising rates in the second quarter of 2015.
Overnight index swaps on Wednesday, which trade based on
expectations for the policy rate, showed traders pricing in a
small chance of a cut next year rather than a hike.
But Scotiabank Chief Currency Strategist Camilla Sutton said
concerns about Canadians' indebtedness, caused largely by
housing purchases, would probably prevent lower rates.
"It's unlikely the Bank of Canada would be able to cut rates
when they have household debt as high or financial stability
risk as high as it is," she said.
Wednesday's policy statement said the housing sector had
been stronger than expected, but this was consistent with
demographics and with people pulling forward their home
purchases because of low rates.
"The bank continues to expect a soft landing in the housing
market," the statement said.
The Bank of Canada targets 2 percent inflation, within a
range of 1 to 3 percent. The rate has been below 2 percent since
The bank's statement on Wednesday said sluggish core
inflation was caused by significant excess supply in the economy
and fierce competition in the retail sector, which it said was
more persistent than it had anticipated. Overall inflation has
been pushed down by gasoline price cuts.
The bank's growth outlook was little changed and it
maintained its projection that the economy would return to full
capacity around the end of 2015.
While housing was stronger than expected, exports and
business investment have continued to disappoint. Exporters have
struggled with soft U.S. demand and a Canadian currency still
much stronger than it was a decade ago.
The Bank of Canada targets inflation rather than the
exchange rate, but does monitor how the currency affects prices
and economic growth.
"The one thing the bank does say is they are still
disappointed in the fact that exports aren't picking up. So I
think if you read between the lines, they do have their eye on
the Canadian dollar and would be perfectly happy go see it at a
lower (weaker) level," said BMO Capital Markets Senior Economist