BoC says economic weakness temporary, keeps tightening bias in place

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The Bank of Canada is seen in Ottawa on September 6, 2011. The Bank of Canada is keeping its trendsetting interest rate anchored at one per cent for the remainder of the year and sending a message that it still believes the cost of borrowing in Canada will go up at some point in the future. THE CANADIAN PRESS/Sean Kilpatrick

OTTAWA - The Bank of Canada is holding fast to its view that the economy is poised for a comeback and that interest rates will need to rise at some point in the future.

The central bank offered no surprises in its Tuesday morning interest rate announcement, keeping the policy setting rate at one per cent for the 18th consecutive announcement date.

And despite what it acknowledges as weaker than expected conditions, bank governor Mark Carney kept in place his future guidance that in all likelihood rates are more likely to rise in the future than fall, or even stay the same.

"Although underlying momentum appears slightly softer than previously anticipated, the pace of economic growth is expected to pick up through 2013," the bank said in its policy statement.

"Over time, some modest withdrawal of monetary stimulus will likely be required, consistent with achieving a two per cent inflation target."

The dollar gained strength after the announcement. It was up 0.19 of a cent to 100.7 cents U.S. — slightly higher than just prior to the central bank's announcement.

The message is that despite the third quarter's disappointing 0.6 per cent growth rate, and likely another sub-par performance during the current fourth quarter, Carney and his policy panel believe the trouble is temporary. The weakness is partly blamed on temporary shutdowns in the oil patch and continued uncertainty over "fiscal cliff" negotiations in the U.S.

Bank of Montreal economist Doug Porter said Carney may be proved correct, but that he would need to radically refashion his outlook if talks in the U.S. capital break down.

Policy-makers calculate that the shock from a series of tax hikes and spending cuts automatically set to kick in January — more like a slope because the effects would not come all at once — could be enough to tip both the U.S. and Canada back into recession.

"I think the bank is hedging their bets on the expected upturn of the Canadian economy," Porter explained.

"We could have the Republicans and Democrats holding hands and singing Kumbaya and the markets would have a tremendous rally and the economy could come flying out of the gate in 2013. The opposite is that we get a bit of a train wreck."

Retaining the bias for higher rates — even as the economy stumbles — also serves Carney's purpose of reminding consumers not to count on super-low rates indefinitely.

While the bank still sees most of the risks to Canada's economy coming from abroad — Europe and the U.S. in particular — Carney has also highlighted the country's overheated real estate sector and high household debt as challenges.

In a bit of a surprise, he said Tuesday he is not as yet convinced the recent cooling in housing activity in Canada, along with a slowdown in credit accumulation, represent a fundamental shift, indicating he remains concerned about the downside risk of keeping rates low for a very long time.

A Canadian Institute of Chartered Accountants survey conducted earlier this year found almost half of respondents worrying about affording to make mortgage payments should rates rise significantly.

On Monday, Finance Minister Jim Flaherty said he was pleased housing was moderating and that Canadians were starting to pay off debt, a shift in the credit and mortgage market he attributed in part to his decision to tighten borrowing rules in July.

Carney said, however: "It is too early ... to determine whether the moderation in housing activity and credit will be sustained."

While the central bank appears to be waiting for the cooling trend to take hold, Scotiabank economist Derek Holt expects Carney will have all the evidence he needs by spring or summer, when the housing correction "starts as a steep plunge in new condo sales." That presents him another problem, however.

"As housing leads the downsides, I think the consumer picture may not lead growth as much as the BoC seems to be hoping," he said.

Otherwise, not much has changed in the past month or so, the bank says. Europe is still in recession, the U.S. is recovering but at a gradual pace and Chinese growth appears to be stabilizing. If there is good news for Canada in all this, it's that commodity prices have remained elevated, which helps the country's terms of trade.

The bank's policy rate has remained anchored at one per cent since September of 2010, the longest stretch of interest rate stability since the 1950s.