BoC says recovery faster than expected, leaves rate unchanged

The dollar lost ground following the rate announcement, trading in the $1.0268 U.S. range, down from as high of $1.0309 U.S. on Tuesday.

The loonie shot upward after the release of the GDP data on Monday, on the anticipation the Bank of Canada may begin raising rates earlier than previously believed.

"There are no indications here that rate hikes are close," said Michael Gregory, senior economist at BMO Capital Markets. "We judge that the bank is waiting for evidence that U.S. economic performance is strong and steady enough to ensure that Canadian exports will contribute to Canadian economic growth regardless of the level of the loonie." (Meanwhile on Tuesday, a key gauge of U.S. manufacturing activity rose in February to its highest level since May 2004.)

The Bank of Canada said there are signs a transition is underway, from an economy powered mostly by consumers to business investment and exports.

"The recovery in Canada is proceeding slightly faster than expected," the central bank, led by governor Mark Carney, said, "and there is more evidence of the anticipated rebalancing of demand."

In its last rate decision on Jan. 18, the central bank said economic recovery in Canada was headed for a period of "more modest growth," with 2.4 per cent expansion expected in 2011. At the time, Carney said the country would be hard pressed to "fully benefit" from an upswing in U.S. prospects due to a lack of competitiveness. But the 2011 outlook is near the low end of expectations compared with private-sector economists, who upgraded their forecasts further after the release of fourth-quarter GDP data.

The statement "did not indicate any significant shift in sentiment regarding Canada's economic outlook," said Dawn Desjardins, assistant chief economist at Royal Bank of Canada.

"The fact that the economy showed stronger than expected momentum in the second half of 2010 did not seem to impress policymakers."

The central bank said domestic demand continues to expand although household spending is "moving" in line with growth in disposable income; business investment continues to "expand rapidly" as companies take advantage of low interest rates and the need to boost competitiveness; and an anticipated comeback by the trade-oriented sector appears to be unfolding.

"There is early evidence of a recovery in net exports, supported by stronger U.S. activity and global demand for commodities," it said, although warning: "The export sector continues to face considerable challenges from the cumulative effects of the persistent strength in the Canadian dollar and Canada's poor relative productivity performance."

Traders have priced in 100 per cent odds of a rate hike in July, once the U.S. Federal Reserve completes its $600-billion U.S. asset-purchase plan. But some analysts say the GDP report tilts the balance back in favour of an interest-rate increase in May.

In the rate statement, the central bank said robust demand from emerging economies is driving the strength in commodity prices, "which could be further reinforced temporarily by supply shocks arising from recent geopolitical events." That was the only reference to the potential risks posed by a growing wave of protests across North Africa and the Middle East.

Global inflation pressures are rising due to higher energy and food costs. But in Canada, the central bank said inflation is in line with its expectations — the core rate, which strips out volatile-priced items, stood at 1.4 per cent in January — and pricing pressures remain subdued, reflecting "considerable slack" in the economy.
© The Financial Post

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