Bank of Canada Keeps Interest Rate at 1 Per Cent, Keeps Eye on Inflation

January 22, 2014 Updated: January 22, 2014

OTTAWA—The Bank of Canada is lowering its forecast for inflation, which has been persistently below the desired target, but keeping its key interest rate unchanged at 1.0 percent. 

The central bank is maintaining a neutral stance on whether its next move will be to raise or lower the rate from where it has been for more than three years, amid a weak economy and low inflation. 

While it sees improvements in the Canadian economy, the Bank of Canada said inflation is now expected to be lower than previously projected—in part because of price competition among retailers. 

It expects the total inflation rate to remain at 0.9 percent in the first half of 2014, down from its previous forecast of 1.2 percent, but to “increase very gradually” and reach the bank’s ideal target of 2.0 percent in the last quarter of 2015.

Canada’s economic growth in the second half of last year was better than expected and should pick up from an estimated 1.8 percent in 2013 to 2.5 percent in both 2014 and 2015, it said. 

‘Canadian dollar remains strong’

Stronger demand in the United States as well as the lower loonie should help boost exports, which will also improve business confidence and investment. 

Following the bank’s report, the Canadian dollar dropped 0.58 of a cent to 90.56 cents US, closer to lows set in early September 2009. 

The currency has lost nearly four cents since Dec. 31, when it closed at 94.02 cents US, due to a combination of factors including a strengthening U.S. dollar, weak prices for commodities, and Canada’s low-interest, low-inflation environment. 

“Despite depreciating in recent months, the Canadian dollar remains strong and will continue to pose competitiveness challenges for Canada’s non-commodity exports,” the bank said in its report. 

That was the key phrase, said BMO chief economist Doug Porter. “This is a strong statement for the Bank, and as close as they will come to saying the currency is still overvalued, and thus further depreciation is welcome,” he wrote in a note. 

Porter also said the emphasis on the potential for inflation to be too low was “ramped up a notch” in the bank’s latest statement. 

CIBC’s Peter Buchanan said the statement “retains a broadly dovish flavour, although the bias as before remains broadly balanced between a possible rate reduction and potential increase.”

The bank expects global growth—led by stronger momentum in the U.S.—to rise from 2.9 percent in 2013 to 3.4 percent in 2014 and 3.7 percent in 2015. 

Weakness in Inflation

But the bank noted that inflation in Canada is expected to “remain well below target for some time,” in part due to increased competition in the retail sector—which keeps the price of goods and services low—and excess capacity. 

So the downside risks have grown in importance, it said. 

“The most important risks are stronger U.S. investment, underperformance in Canadian exports, and imbalances in the household sector,” the report said. 

Canada’s inflation rate rose in November to 0.9 percent, but it was the seventh month in the past 13 months where the official headline inflation reading came in below the bank’s desired broad range of between one and three percent. 

And it’s been consistently below the ideal target of two percent. 

Statistics Canada will release its December inflation figures on Friday.

“The significant and persistent slack in the Canadian economy has contributed to a marked increase since mid-2012 in the proportion of core consumer goods and services for which prices are increasing by less than two percent,” the report said. 

“Heightened competition in the retail sector is also contributing to the weakness in inflation.”

But the bank said the balance of risks remains within the same zone as its last report in October, so it’s decided to maintain its key interest rate target. 

Central banks are usually more preoccupied with high inflation, but low inflation is equally concerning because it’s evidence of weakness in real economic activity and could lead to deflation, where prices actually decline absolutely. 

The bank will make its next interest rate announcement on March 5 and release its updated outlook for the economy and inflation—including risks to the projection—on April 16. 

With files from The Canadian Press