As expected, the Bank of Canada left rates unchanged at 2.75% today. But it indicates that rates will go higher once risks dissipate.

Most economists were calling for no change, while admitting that domestic data could push the Bank to justify a small increase. It noted that the domestic economy is still growing strongly in response to “substantial monetary stimulus,” and core CPI inflation has “risen appreciably above the Bank’s 2% target.” Still, these considerations were overwhelmed by a weaker outlook for the global economy amid “uncertainty about economic, financial and geopolitical developments.”

“In shifting gears from the tightening path seen earlier this year, Governor Dodge is showing just the sort of flexibility and experience that made him the right man for the job,” said CIBC World Markets’ economists in a response to the announcement.

“Despite holding rates steady today, the Bank left little doubt that rates would rise once the uncertainties in the global economy dissipate,” said Bank of Montreal economists. They noted that the Bank of Canada said that “timely removal of monetary stimulus will be required to achieve the inflation target over the medium term.”

The Bank of Canada also said that “particular attention will be paid to ensuring that the relative price movements that are causing inflation to rise do not feed into expectations of generalized price inflation.”

BMO economists said this reflects the Bank’s concern that core inflation could remain above target even after a couple of special factors, rising electricity prices and auto insurance premiums namely, stop exerting upward pressure. “This concern could be realized if economic agents use current inflation trends rather than the target inflation rate as the basis for wage settlements. The risk here is that, should core inflation remain stubbornly high, the Bank might need to unwind the monetary stimulus more quickly than would otherwise be the case.”

CIBC economists said that Dodge has “an education job ahead to convince Canadians that the ongoing inflation run-up is not a lasting problem, one that was initiated with today’s rate announcement”. They said the Bank will have to use words, not poorly-timed rate actions, to ensure that none of this feeds into “expectations of generalized price inflation.”

Financial markets continue to price in strong odds of a quarter-point rate hike in December. But CIBC economists said, “If, as we expect, the risk trio of global economics, finance and geopolitics is no better in December, the Bank will come to the same conclusion then as it did today. Indeed, it won’t be until very late 2003 at the earliest, when the US economy might be out of the woods and due for its own rate hikes, that Canada will recommence its tightening path.”

BMO economists commented, “Looking ahead, we believe the external environment will remain cloudy enough to keep the Bank on hold at the December 3 scheduled announcement date. However, as the global economic environment improves, the Bank will likely resume tightening in January. Overnight rates are projected to peak at 5% by the end of 2003.”