The Canadian Press
OTTAWA — The Bank of Canada is keeping interest rates at historic lows for a few more months, while sending out signals that the economy is rebounding strongly and could trigger inflationary pressures.
The central bank's more positive take on the economy follows Monday's outsized five-per-cent fourth quarter growth announcement and sent the loonie even higher.
"The level of economic activity in Canada has been slightly higher than the bank had projected in January," the bank said Tuesday morning before markets opened.
"The economy grew at an annual rate of five per cent in the fourth quarter of 2009, spurred by vigorous domestic spending and further recovery in exports."
The "slightly higher" language may be an understatement, as the bank had projected growth of only 3.3 per cent for the last three months of 2009.
The bank also noted that "core inflation" has been slightly firmer than projected, although it added that some of the price increases were due to transitory factors.
The governing council continued to reiterate that despite the improved conditions, they would likely leave the overnight rate where it has been since last spring -- at 0.25 per cent -- until at least July.
But some economists weren't buying it and the reaction of the money markets suggested that there may be some pressure on governor Mark Carney to move ahead of schedule.
"They are getting ready to take away the punch bowl," said Derek Holt, vice-president of economics with Scotia Capital.
"I think they are priming the markets for a second-quarter hike."
The next interest rate announcement comes in March, but June would be a more likely time to move, said Holt, if indeed the bank is preparing to act.
The dollar gained almost one cent Tuesday after advancing a cent on Monday and was nudging the 97 cent US level in morning trading.
But most economists agreed Carney is unlikely to act on interest rates until July, noting that Tuesday's announcement repeats the conditional commitment to keep rates at the historic low until the third quarter.
Raising interests would make it more expensive for businesses and consumers to borrow, slowing economic activity and inflation, but likely giving a boost to the already high-flying loonie.
Bank of Montreal economist Michael Gregory said he expects Carney to hike rates by 0.25 per cent in July, and the TD Bank's Francis Fong agreed modest rate hikes can wait until the second half of the year.
"The recovery here in Canada, and indeed around the globe, yet remains heavily dependent on extraordinary monetary and fiscal stimulus, so early rate hikes such as seen in Australia this morning and over the past few months, would need to be warranted by a rapidly overheating economy," said Fong.
There was no sign of that, despite the greatly improved fourth-quarter gross domestic product numbers. The bank also threw up a few red flags against expecting too much of the economy too soon.
"At the same time," it said, "the persistent strength of the Canadian dollar and the low absolute level of U.S. demand continue to act as significant drags on economic activity in Canada."
That is the message Canadians are likely to hear in Thursday's federal budget as well, when Finance Minister Jim Flaherty is expected to say that Ottawa will carry on with the second year of its stimulus spending plans.
On the economy, the bank listed the underlying factors supporting the recovery as policy stimulus, increased confidence, improved financial conditions, global growth and higher terms of trade.
Meanwhile, it said the global recovery is being boosted by domestic demand in emerging markets such as China, and in advanced economies, by "exceptional" monetary and fiscal stimulus.
That would all point to ongoing need for the stimulus for at least the first half of this year, according to many economists.
But hawkish observers pointed to what the bank had said in previous reports and pointedly did not repeat this time as an indication it is feeling nervous about the inflationary impact of emergency low interest rates.
Holt noted that the governing council did not give an estimate on when the economy would return to full capacity, when previously it had pegged the third quarter of 2011. And for the first time in almost a year, the council did not stress that it retains flexibility even at near-zero rates, suggesting it no longer considers there is a realistic risk the economy could again dip.
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