Bank of Canada drops rate-hike talk, sees slower growth


* Omits rate-hike mention for first time since April 2012

* Sees rising risk from persistently weak inflation

* Sees delay in inflation returning to 2 percent target

* Downgrades growth projections across the board

* C$ sinks on news, fixed-income market rallies

By Louise Egan and Randall Palmer

OTTAWA, Oct 23 (Reuters) - The Bank of Canada has abandoned18 months of warnings that interest rates will one day have torise, saying on Wednesday that a soft economy and persistentlyweak inflation mean there is as much chance of a rate cut as arate hike.

The surprise policy shift, which knocked the Canadian dollarto a one-week low and sent bond prices higher, came in astatement in which the central bank kept its key rate at 1.0percent and dropped any hint of an eventual rate increase.

The bank had been signaling since April 2012 that borrowingcosts would have to rise. It was the only central bank in theGroup of Seven major economies to take that stance.

It now forecasts that inflation, which has been below thebank's 2 percent target for the past year and a half, will takesix months longer than it had anticipated to return to target.The bank now expects that to happen at the end of 2015.

The decision to remove the reference to rate increases comesafter the U.S. Federal Reserve surprised markets in September bymaintaining its stimulative bond-buying program due to concernabout the U.S. economic outlook. The United States is by farCanada's biggest export market, and the Bank of Canada notedgrowth there has been slower than expected.

"Uncertain global and domestic economic conditions aredelaying the pick-up in exports and business investment," Bankof Canada Governor Stephen Poloz told reporters. "This leavesthe level of economic activity lower than the bank had beenexpecting."

Poloz added that the bank was more concerned than beforeabout the risk of persistently low inflation. But he also saidthat that danger, which might encourage a rate cut, is balancedby the record-high levels of personal debt that Canadians havetaken on in an era of ultra-low rates.

The governor, presiding over his third rate decision sincetaking the bank's helm in June, said the bank's next move woulddepend on how the economy performs.

Asked whether the risk was balanced between a rate cut and arate hike, he said: "Essentially that's correct, that's offeringup a balanced perspective on where we stand today. We believethose risks are balanced as we sit here."


Still, most economists say there would have to be asignificant shock for the bank to ease policy. Sal Guatieri,senior economist at BMO Capital Markets, said the bank isoffering an even chance of a rate cut or hike in the short term,but that he thinks the bank still sees hikes on the horizon.

"Essentially what they've done is move from a very mild,longer-term tightening bias to a neutral bias," he said.

"We think the risks are fairly balanced over the next yearor so, but we still believe the next move in rates will be anincrease, although not until the first quarter of 2015."

Overnight index swaps, which trade based on expectations forthe central bank's policy rate, showed traders slashing theirbets that rates will rise late next year and pricing in a smallchance of a cut before then.

The Canadian dollar weakened to a one-week low against theU.S. dollar after the statement. The currency was atC$1.0373 versus the greenback, or 96.40 U.S. cents, in earlyafternoon trade, weaker than Tuesday's close of C$1.0289, or97.19 U.S. cents.


Canada's economy bounced back relatively quickly from the2008-09 recession, but growth has been powered largely byconsumer spending and a heated housing market

Poloz, who left his job as head of the country's exportdevelopment agency to head the central bank, had initially beenoptimistic that exports, and then business investment, wouldtake up the baton. He acknowledged this month in Washington thatthe performance of both has been disappointing.

The bank said weakness in the economy means it won't returnto its full production capacity until the end of 2015, the sametimetable it set for inflation returning to target.

The median forecast by more than 30 analysts in a Reuterspoll last week was for the bank to start raising rates in thefourth quarter of 2014. Of those who perceived the bank to havea tightening bias, none expected it to drop that bias or toforgo a nod to a future rate increase.

"A move wasn't viewed as imminent, but that policy statementpushes out any expectation of any rate hikes further into thefuture, and that weighs on the Canadian dollar," said PaulFerley, assistant chief economist at Royal Bank of Canada.

The central bank, as telegraphed in an earlier speech, cutits growth estimates across the board. It reduced itsthird-quarter growth forecast to an annualized 1.8 percent from3.8 percent; fourth quarter to 2.3 percent from 2.5 percent; andgrowth for 2014 to 2.3 percent from 2.7 percent.

The bank also cut its outlook for U.S. growth in the secondhalf of this year. Its overall forecasts for global growth werelittle changed due to positive surprises in the euro zone, Japanand China, but it said the composition of that growth wasslightly less favorable to Canada, which ships most of itsexports to the United States.

Despite its expectation for a soft landing in the housingmarket and a stabilization of household debt, the bankhighlighted the risk of a housing correction if the marketstrengthens further because of low borrowing rates.

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