Bank of Canada keeps overnight rate at 1%

The Bank of Canada says it will need to keep interest rates super-low for an extended period to keep stimulating the economy in the face of a scary global environment and recessionary risks.

As expected, the central bank left its target overnight rate at one per cent on Tuesday for the ninth decision date in a row and gave every indication that Canadians can bank on lending conditions staying “stimulative” for many more.

The loonie dropped immediately after the statement was released at 9 a.m. ET and kept going as markets reacted to the pessimistic tone of the bank’s statement. The dollar, which had briefly breached parity, dipped 1.59 cents to 98.10 US in early trading.

Bank of Montreal economist Michael Gregory said the bank’s removal of a long-standing caution that interest rates will eventually need to rise constituted a strong message to markets.

“The mere fact of going from this slight, vague hint of eventually tightening down the road to, ‘Hey guys, we are doing absolutely nothing for a long time,’ you necessarily then at the margin raise the risk that in the interim rates could actually fall,” he said.

Scotiabank and TD Bank economists didn’t see a rate cut in the offing, but said they believe the central bank is preparing to stay on the sidelines well into 2013.

“Our Bank of Canada call implies a flat overnight rate for over two years – an unprecedented situation which underscores the fragility of the economic recovery,” said TD economist Leslie Preston.

While the rate decision was no surprise, the tone of the bank’s unusually long accompanying statement was darker than some had expected, even though economists were calling on governor Mark Carney to sharply revise the summer’s more sunny forecast.

The bank’s policy team took the advice to heart. Not only is growth braking dramatically in the industrialized world, even China and other emerging nations can be expected to lower their sights for the near future. Most dramatically, the bank said Europe will most likely now experience a recession — a brief one, it said, although it warned Canadians to stay tuned on that bit of optimism.

“The global economy has slowed markedly as several downside risks… have been realized,” the bank said.

“The combination of ongoing deleveraging by banks and households, increased fiscal austerity and declining business and consumer confidence is expected to restrain growth across the advanced economies. The bank now expects the euro area… will experience a brief recession.”

As gloomy as it is, that was the bank’s base-case scenario and it “assumes the euro-area crisis will be contained.” It offered no analysis on what will happen if it isn’t.

Canada’s economy is currently feeling the impact of Europe, the U.S. and slower growth in emerging nations.

“Although Canadian growth rebounded in the third quarter (which ended Sept. 30) with the unwinding of temporary factors, underlying economic momentum has slowed and is expected to remain modest through the middle of next year,” the bank said.

It estimated Canada’s economy likely grew a modest 2.1 per cent this year — most of it in the first quarter — and will fare even worse at 1.9 per cent next year. Both numbers were 0.7 percentage points less than the bank had projected in July.

And a return to normal growth is a long way off, the bank added. Constrained by lower demand for exports, a high dollar, falling commodity prices, skittish markets and a more cautious consumer, it won’t be until the end of 2013 that the economy will return to full capacity, with an average growth rate of 2.9 per cent. That’s more than four years after the official end of the 2008-09 recession.

Given the under-utilization of the economy’s capacity and weakness abroad, the Bank of Canada was not particularly worried about inflation, despite last Friday’s report showing consumer prices rose 3.2 per cent in September, above the bank’s range, and that underlying inflation pressures continue to rise.

The bank said it expects consumer price increases will soon start slowing and bottom out at around one per cent next summer before trending upwards toward the bank’s two per cent target at the end of 2013.

That would suggest the bank might be thinking of cutting the overnight rate before raising it, but the bank appeared comfortable with where it stood.

“With the target rate near historic lows and the financial system functioning well, there is considerable monetary policy stimulus in Canada,” it said.