OTTAWA (Reuters) - The Bank of Canada held its benchmark interest rate at 1 percent on Wednesday, but it revised its guidance dramatically to say that excess capacity in the economy, soft inflation and stabilizing household debt have combined to push any rate increase further away than previously thought.
Governor Mark Carney has been the most hawkish central banker in the Group of Seven (G7) major industrial economies for several months, but he has steadily been watering down his guidance on the need to start raising rates.
“While some modest withdrawal of monetary policy stimulus will likely be required over time, consistent with achieving the 2 percent inflation target, the more muted inflation outlook and the beginnings of a more constructive evolution of imbalances in the household sector suggest that the timing of any such withdrawal is less imminent than previously anticipated,” the bank said.
In October and December it said: “Over time, some modest withdrawal of monetary policy stimulus will likely be required, consistent with achieving the 2 percent inflation target.”
The Canadian dollar swiftly moved lower and bonds rose.
Carney, set to head the Bank of England in July, was the first in the G7 to raise rates following the global financial crisis. Refraining from further tightening since mid-2010, he began signalling in April the need to start raising rates, but has had to dampen expectations repeatedly.
“The Bank of Canada has made (policy) about as soft as they could, while still maintaining that tightening bias,” said Mark Chandler, head of fixed income and currency strategy at RBC Capital Markets.
Desjardins economic strategist Jimmy Jean commented: “The market might interpret this as a prelude to rate cuts.”
Carney told a news conference that, while he would not categorically rule out anything, including lower rates, the bank’s projections include a gradual reduction in monetary stimulus between now and the end of 2014.
“So the direction is clear, the timing has shifted. The timing of that expectation has shifted for the reasons that ... the bank’s governing council has stated,” he said, alluding to excess capacity, muted inflation and improvements in the households sector.
“So all those factors together push back the need for any potential adjustment, any potential tightening, but that is still the ultimate direction.”
One factor that will help Canada, the bank said, will be the end to temporary disruptions in energy output and an expected reduction in the deep discount faced by Western Canadian crude.
That said, the bank does not expect the economy to hit full capacity until the second half of 2014, not the end of 2013 as it forecast in its October Monetary Policy Report.
This is causing a substantially lower inflation profile. Total inflation is expected in the near term to remain around 1 percent, the bottom of the target range of 1 to 3 percent. For the first time since 2009, the bank projects inflation to be below that band in the first quarter. It said total and core inflation should return to its 2 percent target in the second half of next year, not the end of this year as it once thought.
Overnight index swaps, which trade based on expectations for the central bank’s key policy rate, showed that after the announcement traders saw less than a 25 percent chance of a rate increase in late 2013.
The Canadian dollar fell below parity with the U.S. dollar briefly after the bank’s statement, dropping to C$1.0005, or 99.95 U.S. cents, from C$0.9930, or $1.0070, beforehand. It was the weakest since November 19.
A Reuters poll of Canada’s 12 primary dealers on Wednesday found the median forecast is for the next rate hike to be in the first quarter of 2014. Two dealers pushed back their targets; others said their forecast was under review.
The bank said the economy likely grew by only 1 percent, annualized, in the fourth quarter of last year versus initial expectations of 2.5 percent growth.
It also forecast a weak start to 2013, but said growth will gather momentum throughout the year as business investment and exports strengthen and temporary energy sector disruptions end. Annual growth in 2013 should be 1.9 percent, compared with the previous 2.2 percent forecast, it said.
Dizzying household credit growth and a hot housing market have been a top concern of both Carney and Finance Minister Jim Flaherty, but the bank’s language on Wednesday signalled the belief that the situation was getting under control.
The bank expects household credit growth to moderate further and the debt-to-income ratio to stabilize near current levels. It painted a mixed picture of the housing market itself, with residential investment seen declining from historically high levels, but home building still higher than demographic demand.
It said it still saw over building and “stretched” valuations in some segments, despite softening house prices.
Carney said the immediacy of the possible need for higher rates to curb the housing sector was reduced.
However, the bank does list potential housing resurgence as one of three upside risks.
“It’s been a 10-year build-up, and it’s too early to declare success,” said Senior Deputy Governor Tiff Macklem, a possible successor to Carney.
Additional reporting by David Ljunggren.; Editing by Grant McCool, Peter Galloway and Andre Grenon; Editing by Chizu Nomiyama