Bank of Canada maintains one per cent target rate

June 5, 2012

The Bank of Canada held its target for the overnight rate at 1.0% for the fourteenth consecutive decision. Despite some economists and the overnight swap market indicating an expectation for a rate cut within the next 12 months, the Bank’s governor, Mark Carney, closed the announcement with a hawkish statement suggesting that some of the existing stimulus would be withdrawn as future economic conditions improved.

Despite the Bank’s hawkish closing comment, the overall tone of the latest announcement was more sombre than April’s statement. Since the release of April’s Monetary Policy Report (MPR), the noted risks surrounding the European sovereign debt crisis have intensified, recent data from the United States suggest more moderate expansion, and economic activity amongst the emerging market countries has slowed. In combination, these events have led to a degradation of financial conditions, reduced commodity prices, and created a flight to safety among global investors.

With consideration for the described economic conditions, the continuation of a hawkish tone is somewhat less convincing when compared with the April statement. More importantly, the heightened downside risks for the global economy provide strong support for the Bank to maintain its accommodative monetary policy.

Gross Domestic Product (GDP)

Domestically, the Canadian economy continues to be supported by domestic demand, as household and business spending both made positive contributions to growth in the first three months of the year; however, at 1.9%, Q1 2012 expansion was 60 basis points slower than the Bank of Canada’s base-case projection from April’s MPR.

Looking forward, external demand is expected to remain weak, government spending growth will likely remain modest, and domestic demand will continue to be the main driver for Canada’s economic growth. Without an accommodative monetary policy providing support, the ability for consumers to service their sizeable debt burdens and continue to spend would likely be hindered. Further, access to cheap credit provides an opportunity for Canadian businesses to be well positioned for capitalizing on future economic expansion; however, some of this incentive could be mitigated by the recent decline in commodity prices, particularly oil, and reduced expectations for global growth.

Inflation

In April, the Bank stated that inflation would remain close to the 2.0% target until the economy reaches full capacity in the first half of 2013. There was little change in this expectation, but the recent reduction in gasoline prices will likely push headline inflation below 2.0% in the near term.

Canadian Currency

Although the Canadian currency appreciated slightly, the Bank’s announcement had little influence on the CAD, as it remained nearly 4 cents below par with the USD shortly after the announcement.

Next announcement

The next scheduled date for announcing the overnight rate target is July 17, 2012.

Bank of Canada press release: http://www.bankofcanada.ca/2012/06/press-releases/fad-press-release-2012-06-05/

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