Bank of Canada leaves door open to rate cut; Canadian dollar sinks

Reuters
Bank of Canada Governor Poloz takes part in an interview with Reuters in Ottawa
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Bank of Canada Governor Stephen Poloz takes part in an interview with Reuters in Ottawa December 17, …

By Randall Palmer and Louise Egan

OTTAWA (Reuters) - The Bank of Canada said on Wednesday it has become more concerned about weak inflation, and that a "strong" currency is still hampering the country's exports, dovish language that helped send the Canadian dollar to a four-year low.

The central bank also kept its key interest rate on hold at 1.0 percent, as expected, but explicitly stated that its next rate move could be either down or up, depending on economic data.

"We are more concerned about low inflation today than we were three months ago," Governor Stephen Poloz told a news conference. "There's a lot of risk in that analysis. That balance of risk has tilted just a little to the downside, within a zone we would call the neutral zone."

Analysts said the bank was about as dovish as it could be without explicitly saying it was likely to cut rates. They said remarks in its Monetary Policy Report on how the Canadian dollar was still strong, and that its strength still posed an obstacle to exports, was a green light for dollar bears.

Asked later by BNN television whether the door had opened a bit wider to a rate cut, Poloz replied: "The door is slightly more open. However, we still are even-handed about it."

Doug Porter, chief economist at BMO Capital Markets, said the central bank had found a way of signaling to the markets that it would not mind an even weaker currency.

The Canadian dollar fell toward the psychological barrier of 90 U.S. cents, hitting a session low on Wednesday at C$1.1092, or 90.16 U.S. cents - its weakest level since September 2009. It closed at $1.1088, or 90.19 U.S. cents.

Poloz said after the bank's last Monetary Policy Report in October that the bank's neutral stance meant rates could fall as easily as rise, but such language had not been included in the bank's official rate statement until Wednesday.

"The timing and direction of the next change to the policy rate will depend on how the new information influences the balance of risks," it said.

The Canadian dollar has fallen by more than 7 percent against the greenback since the October policy shift.

"Definitely there is scope, I think, if the data does disappoint, for them to introduce an easing bias in the future," said David Tulk, chief macro strategist for Canada at TD Securities, emphasizing that an actual rate cut would only come if inflation data and other economic readings deteriorate.

The bank noted the stimulative impact on exports and economic growth of the Canadian dollar's recent depreciation, especially at a time when the U.S. recovery is becoming more firmly entrenched. The currency's drop will also help drive Canadian inflation upward, it said.

Poloz said currency movements were having less of an effect than they did a decade ago because of increased corporate globalization. So while a weaker Canadian dollar means firms get more for their exports, the companies also have to pay more for inputs because more of the inputs are being imported.

More important than the currency's level is the improved outlook for the U.S. economy, with a weaker currency just "icing on the cake" of stronger U.S. growth, he said.

Led by Poloz since June, the central bank dropped a longstanding bias towards hiking interest rates last October. It has not changed its key rate since September 2010.

"We know that someday interest rates aren't going to be this low. We're obviously indicating it's a long time from now," he told BNN.

In a Reuters poll last week, analysts predicted the bank's next rate move would be a hike, but not until the second quarter of 2015.

Overnight index swaps, which trade based on expectations for the central bank's policy rate, priced in an increased chance of a rate cut by September.

GLOBAL DISINFLATION WORRIES

The bank's increased concern about possible disinflation is shared by policymakers around the world and it comes at a time when global markets are sensitive to interest rate risk.

The U.S. Federal Reserve has begun scaling back its massive stimulus program and there is talk about the Bank of England possibly raising rates. On the other hand, the European Central Bank and Bank of Japan are firmly in stimulus mode.

The bank sees inflation lower than it had forecast in its last report in October, with total and core measures around 1 percent in the first half of 2014, at the bottom end of its target range of 1 percent to 3 percent. But it still sees inflation returning to the 2 percent target in "about two years."

Growth sped up in the latter half of 2013, it said, adding there were few signs exports and business investment were replacing indebted consumers as the drivers of growth.

The bank also revised its forecast for 2014 growth upward to 2.5 percent from 2.3 percent, following anticipated growth of 1.8 percent in 2013.

(Additional reporting by David Ljunggren in Ottawa and Solarina Ho, Alastair Sharp and Andrea Hopkins in Toronto; editing by Peter Galloway, Jeffrey Hodgson and G Crosse)

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