In the release of its July monetary policy report update on Thursday, which discusses current economic and financial trends in the context of Canada’s inflation-control strategy, the Bank of Canada says it outlook for growth and inflation in Canada is largely unchanged from that in its April MPR.

Growth in the first half of 2006 appears to have been a little stronger than projected and the Canadian dollar has traded in a higher range than was envisaged in the April MPR. The economy is currently judged to be operating just above its production capacity.

Growth in 2007-08 is expected to be a little weaker than was anticipated in the April MPR, owing primarily to the lagged effects of the higher Canadian dollar. With some anticipated moderation in U.S. growth, combined with past interest rate and exchange rate increases, the Canadian economy is projected to return to its production capacity by the end of 2008.

The bank projects economic growth of 3.2% in 2006, 2.9% in 2007, and 2.8% in 2008. Total CPI inflation is expected to average just over 1.5% from mid-2006 to mid-2007 — with the reduction in the GST lowering the inflation rate by 0.6 percentage points over this period — and then return to the 2% target and remain there through the projection period. Core inflation should also remain at about 2% through to the end of 2008.

There are important upside and downside risks to the bank’s projection. But the bank continues to judge that these risks are roughly balanced, with a small tilt to the downside later in the projection period because of the possibility of a disorderly resolution of global imbalances.

On July 11, the bank kept its target for the overnight rate unchanged at 4.25%. The current level of this policy rate is judged, at this time, to be consistent with achieving the inflation target over the medium term. The bank will continue to monitor global and domestic economic and financial developments, including adjustments in the Canadian economy, relative to its projection.

Economists on Bay Street, say Bank of Canada’s Monetary Policy Report Update explained its decision to hold interest rates steady earlier this week, and its view that the tightening cycle has likely come to an end.

Bank of Montreal says that the BoC’s decision rests on three main arguments: it has slightly revised down its outlook for growth in 2007 and 2008; underlying inflation is expected to remain on target; and, the Bank now has greater confidence that Canada’s long-run potential growth rate is 3%.

TD Bank reports that the BoC sees the risks to its forecast as being largely balanced. “On the upside, spending by Canadian households may exhibit greater-than-expected momentum while a more pronounced slowing in the United States represents the key downside risk,” it explains.

“Dodge has it right. Not only is the Canadian dollar likely to stay on the firm side, but its drag on growth will be amplified by downside risks to Canada’s key export market in the U.S. Look for the Bank of Canada to keep rates on hold over the balance of 2006 as the world unfolds roughly in line with the policy update’s projections,” says CIBC World Markets.

However, not all economists agree with the BoC’s view. There are dissenters on both the upside and the downside.

“While the Bank is focused on the downside risks for growth in 2007/08, it seems that the clear and present risk is instead to the high side for inflation,” suggests BMO Nesbitt Burns.

“While we expect rates to remain stable in the foreseeable future, the risks appear skewed to the upside given indications of solid momentum in the domestic economy,” agrees BMO. “In addition, the spike up in core CPI inflation in May, though largely attributed to special one-off factors, also stems from upward pressure on resources, especially in Alberta. Should the core rate drift higher this year, the Bank of Canada would likely need to come off the sidelines to subdue inflation expectations and achieve the inflation target.”

Others are more pessimistic. “We see this risk of a U.S. slowdown as playing a more fundamental role in our base-case forecast,” TD says. “As a result, our forecast for Canadian growth of 3.0% in 2006 and 2.7% in 2007 lies below the 3.2% and 2.9% expected by the Bank. We also expect that the excess capacity in the economy will erode at a faster rate, pulling our forecast for core inflation below that of the Bank.”

“Since in our opinion the balance of risks lies more on the side of weaker economic growth than assumed by the Bank, we expect monetary policy to remain unchanged for some time,” agrees National Bank Financial.