October 18, 2007 / 6:27 PM / 13 years ago

WRAPUP 1-Bank of Canada sees rates steady through 2009

OTTAWA, Oct 18 (Reuters) - The Bank of Canada signaled on Thursday it expects to hold rates steady through all of 2009, as weaker U.S. growth, a stronger Canadian dollar and tougher borrowing terms sap strength from the domestic economy.

The interest rate projection, included in the bank’s latest monetary policy outlook, marked a big change from July, when the bank raised rates and said it thought another hike would be needed so robust spending didn’t push inflation too high.

“In this base-case projection, there is no change in the policy interest rate,” the central bank said in its Monetary Policy Report.

The statement was more clear-cut than in the past and caught the market’s attention.

“The bank appears to be sending an unusually clear signal that it neither intends to hike, nor cut rates for the duration of its forecast period, which extends to 2009,” said Jacqui Douglas, economics strategist at TD Securities.

The bank left interest rates unchanged at 4.5 percent on Tuesday. It next sets rates on Dec. 4.

The report reflects changing economic circumstances both in Canada and abroad. The bank lowered its U.S. growth outlook sharply due to the housing downturn, the Canadian dollar has soared and a credit crunch in August has meant a quarter percentage point hike in borrowing costs.

“Things have happened since July obviously. We’ve had financial markets somewhat perturbed... We’ve got a weaker U.S. forecast,” Governor David Dodge told a news conference.

“We think the current policy rate now is appropriate on the basis of that projection that we’ve give you in the report.”

But Dodge stressed that the ground was shifting beneath the bank’s feet as it forged its outlook. The bank is stumped by the speed at which Canadian dollar has strengthened and suggested that some of it might be speculative rather than linked to strong demand for Canadian products.

“The world will undoubtedly turn out to be different than our base projection, that’s almost the one thing we can say for absolute sure,” he said.

The currency has soared to a 31-year high, and that, along with the still-unknown effect of fallout from the U.S. subprime mortgage crisis, are both likely to cool the economy.

On the other hand, domestic demand is now seen growing faster than previously expected in 2008 and 2009.

The bank said the economy ran 0.8 percent above its capacity in the third quarter. But it expects excess demand to evaporate by early 2009. Growth should fall to as low as 1.8 percent in the fourth quarter before recovering to average 2.3 percent in 2008.

It expected inflation —1.7 percent in the year to September — to peak at 3 percent in the fourth quarter and then fall to its 2 percent target in the latter half of 2008, the bank said, earlier than it previously thought.

Dodge said money markets have still not returned to normal after a troubled summer and the complex restructuring of part of the domestic commercial paper market may not be done by a December deadline.

Talks among major financial players to restructure Canada’s nonbank asset-backed commercial paper are “very difficult” and may continue past the mid-December deadline, itself an extension of an original timeline ending this week.

“Given the complexity of what has to be done, it’s not at all surprising to us that it couldn’t be done in two months. Indeed it probably won’t be finished in another two months,” Dodge said.

Canadians have complained that the strong currency has not translated into lower consumer prices, but Dodge said that prices may also be high because demand is so strong.

He urged consumers to demand the best price of retailers and said promoting more competition in the economy would help speed up the adjustment.

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