Bank of Canada holds benchmark rate at 3%

Jamie Sturgeon, Financial Post Published: Wednesday, September 03, 2008

TORONTO -- The Bank of Canada held its benchmark interest rate steady at 3% on Wednesday, noting that dropping commodity prices should dampen inflation, and that overall economic conditions in Canada are "significantly better" than those in most major economies.

Falling commodities prices have eased inflationary concerns, the Canadian central bank said, while, "overall, the level of economic activity is slightly lower than expected in July but still close to the economy's production capacity."

The decision to hold indicated a neutral stance between inflationary concerns and growth, according to BMO economist Doug Porter.

"The bank sounds much less concerned about inflation than they were in July, understandably so, with oil prices falling -- and growth weaker than they expected," Mr. Porter said in a morning note. "Still, there is only a faint hint of concern about the growth outlook."

The bank's one-page statement indicated "they are not quite ready to pronounce that the downside risks to inflation are dominant, but they also aren't quite comfortable saying they are balanced either," Mr. Porter said.

It was the third consecutive rate hold from the Bank of Canada in as many announcements. "In a nutshell, they are on hold unless the floor drops out from beneath the economy," Mr. Porter said.

The market's reaction Tuesday morning was somewhat befuddled. The S&P/TSX composite index was down a slight 10 points to 13,282.3.

As global economic conditions have weakened over the year, commodity prices have tumbled with demand. Commodities are off 16% since the beginning of July alone, led by a sharp decline in the price of crude.

The drop has had a deflationary effect, but global concerns "remain elevated" the bank said.

As for economic growth at home, "domestic demand has slowed modestly but remains strong," the bank said. "It continues to be supported by financial conditions that remain significantly better than those in most other major economies and by income gains stemming from past improvements in the terms of trade."

Figures released last week put real gross domestic product growth for the second-quarter at 0.3%, up modestly from a first-quarter contraction of 0.8%.

"Given these developments, the Bank judges that the current level of the target for the overnight rate remains appropriately accommodative," the Bank of Canada's statement said.

The bank's view on what course it may take at its next rate announcement on Oct. 21 was also difficult to discern, Mr. Porter said, giving only the slightest indication that the central bank may make a cut.

"On balance, the statement was much less dovish than most anticipated, with only a nod towards a slower growth and lower inflation outlook," Mr. Porter said. "Notably, the bank did not make a call on the balance or risks -- if one looks really hard, there is a hint of a dovish bias, but one would need a microscope to find it."

"It seems that it's going to take much more severe weakening to get the bank talking rate cuts," Mr. Porter said.

Financial Post