Dollar surges as Bank of Canada interest rate unchanged

The Canadian dollar soared nearly a penny in trading Tuesday after the Bank of Canada decided to keep its benchmark overnight interest rate steady at one per cent.

The loonie closed at $1.0517 US, a jump of 0.88 of a cent compared with Monday's close of $1.0429.

The currency rose as economists interpreted the Bank of Canada's decision to hold firm as further evidence of a coming rate hike when the central bank meets later in the year.

"Our expectation [is]...for the bank to make good on its promise to withdraw 'some of the considerable monetary policy stimulus currently in place' with the case for a September hike," said RBC assistant chief economist Dawn Desjardins in a commentary after the rate decision Tuesday morning.

Steady as she goes

For its part, the central bank said Canada currently faces an uncertain international economic situation with European and U.S. debt concerns dominating the fiscal landscape.

"The U.S. economy has grown at a slower pace than expected and continues to be restrained by the consolidation of household balance sheets and slow growth in employment,"  the bank said in a press release.

"While growth in core Europe has been stronger than expected, necessary fiscal austerity measures in a number of countries will restrain growth over the projection horizon."

Canada is growing roughly as the central bank had forecast, but the country still faces a threat to its slowly recovering export sales, partly because of weak U.S. economic growth and partly because of a rising Canadian currency.

Growth versus inflation

Economists had split as to whether the bank would raise its overnight borrowing rate or keep the trend-setting interest rate at its current, record-low level as the July decision approached.

Late last year, Bank of Canada governor Mark Carney talked extensively about the need for Canadians to rein in their personal debt levels, a signal many experts interpreted as the central banker about to get tough on rising prices.

Many economists began predicting that the bank would boost rates in July, especially after three months — March, April and May — when inflation popped above the central bank's one-to-three-per-cent target range for price growth.

Carney, however, began signalling a change of sentiment in June when he talked about the financial "headwinds" Canada faced in an interview with the Wall Street Journal.

His wording led to a subtle shift in thinking among Carney watchers.

"The hard place that Carney is caught between is the growing risk that Canada’s economy will underperform expectations if U.S. demand remains weak and/or Europe's credit crisis erupts and spews lava across global financial markets," said BMO Capital Markets economist Sal Guatieri in a commentary prior to Tuesday's rate announcement.

Economic growth — something central bankers are trained to generally ignore — began pushing out concerns over rising prices in the bank's thinking, experts said.

Still, many economists believe the Bank of Canada will boost interest rates toward the end of 2011 as long as the Canadian economy keeps to its current decent GDP growth path.

RBC Economics, for example, currently predicts that Canada's economy will grow at a 3.2 per cent clip in 2011, equal to the growth rate for 2010.

Europe and America

There are growing fears that the Greek debt crisis is spreading to other European countries, especially the continent's third biggest economy — Italy.

As well, the administration of U.S. President Barack Obama has so far failed to reach a deal with the U.S. Congress over whether to raise Washington's borrowing ceiling.

Failure to get an agreement by Aug. 2 risks placing the world's largest economy in technical default of it debt obligations.

Both situations hold the potential to drive the global economy back into a recession similar to the one in 2008-09 or at least to reduce the potential economic growth for most countries, experts have warned.

Into the winter

Still, the Bank of Canada said it is eyeing rate hikes into the later months of 2011.

"To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn," the bank's statement said.

The central bank now forecasts that Canada will expand by 2.8 per cent in 2011 and 2.6 per cent in 2012, the year that the bank expects the Canadian economy will reach full capacity.

As well, Canada's core inflation — price increases once volatile items, such as gasoline and food prices are subtracted — will stay at the two per cent level, basically where Carney believes it should be for Canada's economy to function at peak performance.