December 6, 2017 / 3:12 PM / 5 days ago

UPDATE 2-Bank of Canada holds rates, markets still guessing

(Adds market reaction, analyst comment)

By Andrea Hopkins and Leah Schnurr

OTTAWA, Dec 6 (Reuters) - The Bank of Canada held interest rates steady on Wednesday, as expected, and took a cautious tone even as it said more rate hikes are likely in store amid diminishing slack in the labor market and signs of inflation pressures.

Striking a more dovish tone than expected after very strong employment data, the bank gave few hints at when the next rate hike will come, reducing expectations it would move as early as January. The Canadian dollar sagged in response.

“I think on balance their overwhelming focus remains on the uncertainties ... so they provided no clue of a rate hike anytime soon, which is a strong message to markets that they are not going to budge until they get further clarity on NAFTA and other related risks,” said Derek Holt, head of Capital Markets Economics at Scotiabank.

While the bank held firm with a warning that more rate hikes are likely in store after moves in July and September, it noted uncertainty about trade and other geopolitical developments.

Economists fear Canada’s export-driven economy would be hurt by the demise of the North American Free Trade Agreement, which U.S. President Donald Trump has targeted for overhaul. Some 75 percent of exports go to the United States.

The Canadian dollar weakened as investors reduced the odds of a rate hike early in 2018, touching C$1.2777 to the U.S. dollar, or 78.27 U.S. cents, from 1.2664 before the rate decision.

Unexpectedly strong job gains in November took the unemployment rate to 5.9 percent, its lowest since February 2008, but the bank said other indicators point to ongoing, albeit diminishing, slack in the labor market.

“It is a little bit surprising how strongly they are leaning against the recent improvements in the labor market data,” said Andrew Kelvin, senior rates strategist at TD Securities.

Paul Ferley, assistant chief economist at Royal Bank of Canada, said the bank will resume rate hikes if economic data is sufficiently strong through the second quarter of 2018.

The central bank said recent Canadian data are in line with its October outlook, though it noted inflation has been slightly higher than expected, reflecting the continued absorption of economic slack.

It noted that business investment continued to contribute to growth after a strong first half to 2017, and said public infrastructure spending is becoming more evident in the data. (Reporting by Andrea Hopkins; Editing by Frances Kerry and Meredith Mazzilli)

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