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Bank of Canada Governor Mark Carney held his benchmark interest rate at 1 percent Tuesday, chopping his domestic growth forecast for 2011 and 2012, amid a host of threats including a "brief recession" in the euro zone.
In explaining the decision to leave borrowing costs alone, for a ninth consecutive meeting, as expected, the central bank hinted it is not yet considering an interest rate cut, saying there is "considerable monetary policy stimulus" in Canada and the financial system is working well.
Nonetheless, Carney and his policy team warned that the United States -- Canada's chief export market -- will suffer from weak growth through 2012, and said while there forecast assumes the European debt crisis will be contained, that assumption is "clearly subject to downside risks."
Moreover, in a teaser to a quarterly forecast they will release tomorrow, policy makers significantly downgraded their Canadian growth projections for this year and next, as the gloomier global backdrop affects financial conditions, consumer and business confidence and trade.
While the bank now sees faster growth in 2013 than at the time of its last forecast in July, policy makers said the economy will take until the end of that year to return to full capacity -- compared with its July prediction of mid-2012. Also, inflation will slow before gradually inching back up to the bank's 2-percent target by end of 2013, the bank said.
"The combination of ongoing deleveraging by banks and households, increased fiscal austerity and declining business and consumer confidence is expected to restrain growth across the advanced economies," the central bank said.
"Although Canadian growth rebounded in the third quarter with the unwinding of temporary factors, underlying economic momentum has slowed and is expected to remain modest through the middle of next year."
Carney's decision comes a day before a crucial summit in Europe aimed at stemming the continent's debt mess before it engulfs the financial system there and threatens to cause another global recession. Already, the central bank says the euro zone will experience a short downturn, as belt-tightening measures and the sporadic political response to the crisis squeeze consumers and sap business confidence.
Later this week, leaders from the Group of 20 nations will meet in France to try and stop the slide in investors' faith that they can put the global economy back on more solid footing. (Also at the summit, Carney is expected to be officially tapped to lead the Financial Stability Board, the global body tasked with co-ordinating the overhaul of international banking rules.)
The central bank cut its growth forecast for Canada in 2011 to 2.1 percent from 2.8 percent in July, and sliced its 2012 forecast to 1.9 percent from 2.6 percent. However, policy makers predict a marked improvement in 2013, with the economy growing at a healthy 2.9-percent pace.
Household spending, a linchpin through much of the recovery, will "grow relatively modestly," the bank said, as lower commodity prices and volatility in markets weigh on Canadians and their sense of financial well-being.
Business investment will continue to "grow solidly," the bank said, as firms take advantage of low borrowing costs and a higher currency that makes it easier for them to invest in state-of-the-art machinery and equipment, but will also be "dampened" by the global outlook.
Indeed, softer global demand is occurring at a time when the currency -- which is now hovering around parity with the U.S. dollar again -- is also causing headaches for exporters as they try to crack new markets around the world.
Although Carney and his officials pointed out that there is "considerable" stimulus in place with borrowing costs near historic lows, their inflation forecasts suggest they cannot completely rule out a reduction in borrowing costs. At the very least, they imply that the central bank has the flexibility to leave rates on hold all the way through next year and even into 2013, if necessary.
Despite hotter-than-expected inflation readings in recent months, policy makers said the drop in energy prices since the summer and a slowdown in big emerging markets like China will tame global inflationary pressures, and this will spread to Canada, too.
Canadian core inflation, a measure which strips out items like energy and fresh fruit, will drop through 2012 before returning to target by the end of 2013, the bank said, and total inflation will fall to as low as 1 per cent by mid-2012 before rising.
The central bank, whose next decision is scheduled for Dec. 6, will expand on all of these themes in its full forecast tomorrow, followed by a press conference with Carney and Senior Deputy Governor Tiff Macklem.