Bank of Canada holds rate steady at 1%

Bank of Canada governor Stephen Poloz is keeping the trend-setting interest rate at one per cent, even as inflation rises and there are signs of a "broadening" economic recovery.

In its interest-rate announcement Wednesday, the central bank warned of risks to the Canadian economy such as sliding oil prices and high household debt.

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But it said that an improving U.S. economy bodes well for Canadian exports, despite disappointing global growth.

The Canadian dollar moved upward on the news, trading at 87.98 cents US, up 0.21 of a cent from Tuesday's close.

"Canada's economy is showing signs of a broadening recovery," the bank said in its statement.

Canada's gross domestic product expanded at a 2.8 per cent annual pace in the third quarter, an unexpectedly high rate powered by improved exports and expanded household spending.

"Stronger exports are beginning to be reflected in increased business investment and employment," the central bank said in its statement today.

"This suggests that the hoped-for sequence of rebuilding that will lead to balanced and self-sustaining growth may finally have begun."

Rate unchanged since 2010

In setting its benchmark interest rate, which has been unchanged since September 2010, the Bank of Canada tries to weigh the risk of inflation, currently at 2.4 per cent, against the danger of restraining the economy with higher rates.

"Overall, the balance of risks remains within the zone for which the current stance of monetary policy is appropriate," the Bank of Canada said.

The bank acknowledged Wednesday that inflation had climbed faster than expected, but described the increase as "temporary effects" of a lower Canadian dollar. Lower fuel prices will ultimately help temper the impact of a higher dollar.

The central bank said the output gap appears to be smaller than it had predicted in its October monetary policy report, but there was still significant slack in the economy.

The unemployment rate is falling amid the recovery of manufacturing in Central Canada, but there is still unused capacity in the sector and many people who have been out of work for extended periods — which bankers define as "slack."

The Bank of Canada is not expected to raise its benchmark rate until the U.S. Federal Reserve lifts interest rates, likely sometime in 2015.

Concern over household debt

Derek Holt, vice-president of Scotiabank Economics, expressed concern about the bank’s statement of financial stability risks because of high household debt.

“This is a bit more severe than the normal tone that the BoC has taken under Poloz," Holt said in a note to investors.

He said that "policymakers have to be very careful in avoiding moves that would add to the risk of a hard landing as opposed to a more gradual deleveraging from current levels.”

Holt was critical of Poloz’s statement as being too encouraging about recent readings for the economy, while downplaying the inflation risk and the potential impact of lower commodity prices.

TD Bank economist Randall Bartlett also sounded the alarm about inflation, saying core consumer price index inflation has remained persistently high.

“With the dollar having fallen further since the October Monetary Policy Report [by the Bank of Canada], the lower loonie could ultimately lead to price increases in import intensive sectors, particularly those that have smaller margins available to absorb exchange rate volatility,” Bartlett said.

The central bank seems to be relying on oil prices remaining low to contain inflation risk, he said, but that is not a given in today’s volatile markets.