* BoC holds key rate at 1 percent
* Cites Europe, U.S. woes as backdrop for policy shift
* Sees Canadian growth resuming in second half of year
* Says inflation pressures dampened
* Cdn dollar gains, markets pare rate cut expectations
By Louise Egan and Randall Palmer
OTTAWA, Sept 7 In a dramatic policy shift, the
Bank of Canada said on Wednesday it saw less need to raise
interest rates, becoming the latest major central bank to take
a more cautious stance about the worsening global economy.
The bank held its overnight rate unchanged at 1 percent,
where it has been for the past year, and took its previous talk
of a rate hike off the table.
"In light of slowing global economic momentum and
heightened financial uncertainty, the need to withdraw monetary
policy stimulus has diminished," the central bank said in a
In its July interest rate announcement, the bank said
stimulus "will be withdrawn" provided the economy kept growing,
leading markets to expect a rate hike later this year.
That forecast looks outdated now, given the European debt
crisis, slowing U.S. growth and volatile markets.
Investors were not surprised by the more dovish tone,
although many had expected a sharper policy reversal. Most
economists still expect the next move in rates to be up rather
than down, but it could be a year or more before that happens,
and the bank's cautious language left the door open to an
eventual move in either direction.
Instant View: [ID:nN1E78607Z]
Graphic on rates, inflation: r.reuters.com/buh63s
Interactive Americas graphic: r.reuters.com/qac63s
Goldman Sachs this week became the first major financial
institution to forecast a Canadian rate cut later this year.
"There is really not much hint that the bank is considering
cutting rates, but at the same time, they've pretty much put
rate hikes firmly on the shelf," said Doug Porter, deputy chief
economist at BMO Capital Markets.
TOEING THE INTERNATIONAL LINE
The change of heart brings the Bank of Canada into line
with other major central banks ahead of a G7 meeting on Friday
where policymakers are expected to commit to keeping monetary
stimulus in place. Brazil cut rates on Aug. 31 and the European
Central Bank is widely expected to halt its tightening cycle on
Thursday, with some investors pricing in a cut in ECB rates
later this year. [ID:nL5E7K24FK]
The U.S. Federal Reserve, taking a leaf out of Canada's
mid-recession playbook, has promised to leave interest rates
low for a prolonged period.
Yet for some, the Bank of Canada was less dovish than
"It still has these lingering elements of the hawkish,"
said Stewart Hall, currency strategist at RBC Capital Markets.
"Most, including ourselves, were looking for more of an
overt move to neutrality that would have, in a sense, sidelined
any talk of the need to withdraw monetary stimulus."
The Canadian dollar weakened briefly against the U.S.
dollar after the Bank of Canada statement, but later
strengthened as market players realized the bank wasn't calling
for a rate cut. <ID:nN1E7860DN> Swap markets pared back
expectations for a near-term drop in rates but were still
pricing in a cut in early 2012. BOCWATCH
The yield on the two-year Canadian government bond
CA2YT=RR, which is especially sensitive to Bank of Canada
interest rate moves, rose to 0.905 percent from 0.883 percent
just before the statement. <0#CABMK=>
The bank said several of the downside risks it identified
in its July Monetary Policy Report had materialized, yet it
sees Canadian growth resuming in the rest of 2011 after a
second-quarter contraction. Exports will remain "a major source
of weakness" because of soft demand from major trading partners
and a strong currency, it said.
Derek Holt, economist at Scotia Capital, said the bank
appeared to be over-optimistic on growth, although he still
expects the next move on rates to be up.
"I think we had a weak economy throughout the first half of
the year and there are more considerable question marks about
the outlook over the next six to nine months than the bank is
letting on, but we'll see," he said.
The Bank of Canada said headline inflation will continue to
moderate and core inflation will remain contained, and that
overall inflation expectations are well-anchored.
It cited discouraging U.S. economic data, the European
sovereign debt crisis and market volatility as the backdrop to
its policy shift, noting that U.S. growth will be weaker than
previously expected and fiscal and financial strains in Europe
could prompt even more severe market dislocations.
Economists and strategists in a Reuters survey released
Aug. 31 had expected the bank to stay on the sidelines at least
until the second quarter of next year. In July, analysts had
predicted a rate hike in the fourth quarter of 2011.
(Additional reporting by Claire Sibonney, Trish Nixon and Euan
Rocha; Writing by Louise Egan; editing by Janet Guttsman and