Bank of Canada says low interest rates 'appropriate for a period of time'

OTTAWA – The Bank of Canada is hinting it is less concerned about household debt levels, making it possible to keep attractive interest rates in place longer to spur investment and economic growth.

As expected, the central bank kept its overnight policy rate at one per cent on Wednesday, the level that has been in place for about two-and-a-half years to ease Canada’s recovery from the 2008-9 global financial meltdown.

But the bank also signalled a mild change in its thinking by softening its closely followed forward-looking guidance on rate hikes, suggesting it now expects the current rate to remain in place longer than it had previously expected.

Its statement also mentioned a “constructive evolution” in household finances.

“With continued slack in the Canadian economy, the muted outlook for inflation, and the more constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time,” the bank said.

Some economists had been expecting the bank to drop its bias towards a tighter monetary policy altogether, but the statement did not go as far.

Still, markets saw the shift as dovish enough to drop the Canadian dollar to a fresh, eight-month low, down 0.49 of a cent to 96.79 cents US following the announcement.

Several factors influence the dollar’s value, including commodity prices, the strength of the domestic economy and the spread between Canadian and U.S. interest rates. Higher rates here tend to make the loonie more attractive.

“I think the bank made it just a little more explicit that they see rates going nowhere any time soon. I think this pretty well locks in the view that there won’t be any rate hikes in 2013,” said Doug Porter, chief economist with BMO Capital Markets.

Scotiabank economist Derek Holt said retaining the statement’s tightening bias, even if in a milder form, was in part intended to send a message that the Bank of Canada is not contemplating cutting rates either.

The bank’s governing council cited continued slack in the economy and the extremely low inflation rate as reasons for keeping the interest rate where it is, and the healthier outlook for household finances and debt as alleviating some of the pressure to raise rates.

In the past, outgoing bank governor Mark Carney — who leaves his post in June — said he was worried that low rates were luring Canadians into taking on debt they could not afford to service once interest rates rose.

In January, the bank had noted the beginnings of restraint in household spending, but in the latest statement to bank sounds more certain, stating “residential investment is expected to moderate further.”

It adds that the 165 per cent record high household debt-to-income ratio is stabilizing at current levels.

Despite the softer tone on interest rates, the bank’s governing council does not appear ready to abandon its view that the Canadian economy, after going through a rough patch in the second half of 2012, is on the mend.

In what economists call an overly optimistic outlook for Canada’s prospects, the bank said in January it expects real gross domestic to advance by two per cent this year and 2.7 per cent in 2014.

The bank acknowledges the disappointing nature of the fourth quarter growth rate of 0.6 per cent, but blames most of that weakness on a sharp reduction in inventory investment. Most domestic components of gross domestic product actually produced “solid growth,” it said.

“”The bank expects growth in Canada to pick up through 2013,” it adds, “supported by modest growth in household spending, combined with a recovery in exports and solid business investment.”

That is still too rosy for most economists. Porter said the consensus that will be given to Finance Minister Jim Flaherty on Friday for his upcoming budget will likely be tepid growth of about 1.6 per cent this year, measurably below the bank’s 2.0 per cent call. Most analysts also think the bank’s projection for a 2.7-per-cent GDP advance in 2014 is to high.

Capital Economics analyst David Madani says the bank will eventually need to acknowledge that the economy is far weaker than it projects, and that its chosen engines of growth are sputtering.

Specifically, Madani says the central bank’s faith in robust business investment is misplaced.

“The bank is well aware of the ‘continued discounts for Canadian heavy crude oil,’ but it seems to have failed to connect the dots between this fact and the recent scaling back in business investment intentions,” he said. “In addition, we expect housing activity to continue softening.”

Madani says even his low-ball 1.2 per cent growth projection now faces the risk of being optimistic.

While not as pessimistic, BMO’s Porter agrees that the bank will likely need to revise downward its forecast for 2013 at its next interest rate announcement in April after it has more hard data pointing to a slower than expected start to the year.