Bank of Canada holds rate at 1% as outlook worsens

The Bank of Canada kept its target for the overnight rate steady at 1.0 per cent on Tuesday, citing a worsening global economy for the need tomaintain the current level of stimulus.

The bank hinted it may have to keep its benchmark interest rate that low for an extended period, surprising those who have been expecting a rate hike sooner rather than later.

The Canadian dollar, which had been above par with the U.S. dollar before the bank's announcement, fell precipitously on the news, closing down more thana centat 98.40 cents US. Although no rate change was anticipated Tuesday, investors had expected a more hawkish tone from the bankwith regard to raising interest rates.

The central bank said that the risks to Canada's economy were "roughly balanced" and as such there was no need for a change at this point. "[But] the global economy has slowed markedly as several downside riskshave been realized," the bank said in its accompanying statement.

Debt troubles in Europe continue to have an effect, asdoes theslowdown in the U.S. and emerging markets. Canada's export-driven economy is heavily dependent on all of those markets for growth.

It was the ninth consecutive time that the central bank has decided to hold the rate, since it raised it to 1.0 per centfrom 0.75 per centin September 2010. The bank's leaders, including governor Mark Carney,meet every six weeks to discuss where to set its benchmark interest rate.

"Our base case remains that the Bank of Canada will keep rates unchanged until the start of 2013," BMO economist Michael Gregory said in a commentary. "If anything, todays announcement increases our conviction."

The bank says Canada's economy likely grew a modest 2.1 per cent this yearmost of it in the first quarter and will fare even worse at 1.9 per cent next year. Both numbers were 0.7 percentage points less than the bank had projected in July.

The bank also said it saw some "significant risks" with regard to its inflation outlook. Earlier this month,Statistics Canada reported that Canada's inflation rate inched higher to 3.2 per cent in September. And the core rate (which strips out volatilefood and gas prices)was 2.2 per cent.

The Bank of Canada aims to keep inflation between 1 and 3 per cent, and 2 is the midpoint of that inflation-control target range. This target is expressed in terms of total CPI inflation, but the Bank uses a measure of core inflation as a guide.

September was the first time the core ratehas been above 2 per cent since February 2010.

But the bank said it is confident the inflation jump will be temporary, as a weakening economy will keep it under control.

"As a result, core inflation is expected to be slightly softer than previously expected, declining through 2012 before returning to 2 per cent by the end of 2013," the bank said in its statement Tuesday.

Only months ago, the burning question was when the central bank might hike again. Now, the spectre of a rate cut is emerging.

"The Bank now appears to have an unequivocal neutral policy bias which necessarily raises the risk of an ease from where it stood before," Gregory noted.