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Bank of Canada expected to stand pat, soften tone

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The Bank of Canada is expected on Tuesday to do the same thing it’s done the last 15 times it has announced its benchmark interest rate: stay put at one percent.

An increasingly fragile global economy and slowing inflation means Governor Mark Carney, has no pressing need to quickly raise interest rates, according to a number of Bay Street economists and strategists. Add to that mix Ottawa's recent tightening of mortgage regulations, which are expected to add further pressure to an already-cooling housing market, and the prospect of an interest rate hike becomes even more remote.

Economists at Bank of America Merrill Lynch say the three-month overnight index swap market -- a key indicator for benchmark interest rates -- is pricing about a 45-percent chance of a rate cut by the end of the year.

“There is a clear disconnect between Bank of Canada’s (BoC) hawkish bias and market expectations. Since April, the BoC has been signaling that it may be leaning toward hikes by inserting the phrase that ‘some modest withdrawal of the present considerable monetary policy stimulus may become appropriate,’” David Grad, FX strategist at Bank of America Merrill Lynch, says in a note to clients.

“Therefore, although the market does not expect a change in monetary policy on Tuesday, it likely sees a high chance that the BoC will remove the key phrase and shift to a neutral stance on monetary policy.”

In April, Carney and company became far more bullish in tone and hinted that Canadians should prepare for higher interest rates. But an ongoing sovereign debt crisis in Europe and slowing economic growth in both the U.S. and China -- the world’s two largest economies -- has seen it pullback on such language.

Central banks in both Europe and China, among others, have slashed their benchmark rates since the last time the Bank of Canada announced its rate.

A similar situation where the bank was forced to backtrack from hints it would raise interest rates played out in 2011.

“There is certainly a strong case to shift back to neutral: 1) In recent weeks, almost every major central bank in the world has eased policy amid slower global growth. 2) Canadian GDP likely grew at less than a 2-percent pace in the first half of 2012, versus the Bank’s forecast of 2.5 percent. 3) Ottawa’s steps to tighten mortgage insurance rules (and thus dampen the housing market) ease the Bank’s biggest domestic concern,” says Douglas Porter, deputy chief economist, at BMO Capital Markets.

Inflation has also become less of a concern, as annual inflation tumbled to 1.2 percent in May, hitting its lowest level in more than two years and well below the bank’s target of 2 percent. Core inflation, which strips out volatile items such as food and energy, fell to 1.8 percent.

Economists predict that June inflation figures to be released next Monday will come in at 1.8 percent, while core inflation is expected to rise to 2.3 percent. While that would top the central bank's 2-percent rate for inflation, it will keep it within its targeted band between one to three percent.

“The Bank of Canada should do nothing. Canada’s both fiscal and monetary position is about right,” Bill Cheney, chief economist at Manulife Asset Management, tells BNN.

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