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Bank of Canada stands pat at 1%, cuts forecast

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The Bank of Canada maintained its benchmark interest rate at one percent on Tuesday and cut its GDP forecast for 2012 and 2013, citing a weakening global economy.

The central bank now expects the Canadian economy to grow 2.1 percent in 2012, below its previous forecast of 2.4 percent. Its forecast for 2013 was lowered to 2.3 percent from 2.4 percent. But it did hike its 2014 GDP forecast to 2.5 percent from 2.2 percent.

“While the economic expansion in the United States continues at a gradual but somewhat slower pace, developments in Europe point to a renewed contraction,” the central bank said in a statement.

“In China and other emerging economies, the deceleration in growth has been greater than anticipated, reflecting past policy tightening and weaker external demand.”

The central bank expects the output gap -- which is the difference between the actual and potential output of the economy -- will now close in the second half of 2013 rather than in the first half.

The Bank of Canada continues to believe the European debt crisis -- which has rattled global equity markets and acted as a drag on world economic growth -- will be “contained,” but warned that assumption is subject to “downside risks.”

But Governor Mark Carney did not significantly soften his tone from the June announcement, once again saying: “To the extent that the economic expansion continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate.”

Economists were widely expecting the central bank to hold tight on interest rates, but were wondering whether it would further backtrack on the bullish comments it made in the spring.

“There’s no surprise in any of this, with the Bank citing the visible deceleration in global growth as the key to a softer Canadian view, and relying on domestic private demand to drive Canada,” says CIBC economist Avery Shenfeld. “As for markets, they are so far ahead of the Bank, pricing in rate cuts rather than hikes, that the slightly softer view in this forecast versus the prior one is hardly newsworthy. If anything, the Bank’s message is a warning to those long the front end of the Canadian yield curve, with Carney’s team not seeing nearly enough of a threat to growth to even think about the prospect of cutting rates any time soon.”

Other economists say it’s only a matter of time until the Bank of Canada will begin backtracking.

“Overall, with most other central banks now either cutting interest rates or providing additional stimulus, we suspect that it won't be long before the Bank of Canada moves completely to the sidelines,” says David Madani. “We maintain our forecast that the bank's key interest rate will remain at 1 percent this year, next year and in 2014. We still think that more policy support might eventually be needed.”

The Bank of Canada continues to believe that the biggest risks to the Canadian economy will come from outside the country.

“While global headwinds are restraining Canadian economic activity, domestic factors are expected to support moderate growth in Canada,” the central bank said. “Consumption and business investment are expected to be the primary drivers of growth, reflecting very stimulative domestic financial conditions.”

The central bank once again warned about “record-high household debt” and the impact on incomes and wealth from slumping commodity prices.

The Bank of Canada expects the consumer price index to remain “noticeably” below its 2-percent target over the next year. It also expects core inflation -- which strips out volatile items such as food and energy -- to remain around 2 percent.

Tuesday’s announcement to hold the line on interest rates marks the 15th consecutive meeting where the central bank has decided not to move its rate. The last time it moved its benchmark rate was in September 2010.

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