The Bank of Canada (Boc) today announced that it is maintaining its target for the overnight rate at 4.25%. The operating band for the overnight rate is unchanged, and the Bank Rate remains at 4.5%.

IIn its commentary accompanying Tuesday’s rate decision, the central bank said that while economic growth in the first half of this year has been higher than expected, its outlook for 2007 and 2008 is now weaker than it initially forecast back in April.

“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 Boc said.

In the wake of the BoC’s decision to hold the line on rates, the Canadian dollar was down 0.56 of a cent at US88.31¢ on currency markets.

Bay Street economists said that the policy statement accompanying today’s rate decision by the BoC was more dovish than expected.

As well, BMO Nesbitt Burns noted today’s decision is the first time since last July that the central bank did not hike rates by 25 bps at a rate-setting meeting. “In light of recent high-side surprises for both growth and inflation, the tone of today’s press statement was more dovish than widely expected, with the Bank again highlighting the growth risks in 2007/08,” BMO Nesbitt said.

BMO Nesbitt said that effectively, the BoC is suggesting that, as things stand, they are through tightening. “It doesn’t get much clearer than that,” it adds.

National Bank Financial agreed, “The Bank’s intention is to stay on the sidelines. Like the Bank’s
projection, our own forecast calls for some moderation in U.S. growth, accordingly we see the Bank staying on the sidelines,” it said.

TD Bank said that it views this move to the sidelines as, “representing the end of the Bank’s tightening cycle versus a temporary pause on the road to higher rates.”

“Our take is that the Canadian economic expansion is set to slow in the coming months, albeit from a very healthy starting point,” TD noted. “First, similar to the Bank, we see that the U.S. economy is beginning to lose momentum, a trend that should intensify and continue through the second half of the year. Second, the strength in the domestic economy, which has powered growth ahead in early 2006, looks to be showing some wear around the edges as two of the last three monthly GDP releases have shown a tepid 0.1% increase.”

However, it warned that there are indications of a very tight labour market, and strength in core inflation. “As such, we cannot totally eliminate the risk that a further hike in rates may indeed be necessary,” it cautions.

RBC Financial Group called the report, “disappointing because it raises the risks that the Bank will have to resume a rate hike campaign in order to quell inflation pressures that we expect will develop as the tight labour market boosts wage pressures and the housing market continues to fire on all cylinders.”

“Increasingly the risks will be to the upside for inflation should the Bank maintain a policy rate that by our estimate remains simulative. While the Bank is clearly leaning to keeping the policy rate unchanged for the near-term, we expect long-term market interest rates to rise later this year as worries about inflation develop,” RBC added.

“A small majority of analysts was expecting no move today, as were financial markets, but many were looking for a more hawkish tone in the statement. Accordingly, today’s generally stand-pat statement was seen as quite dovish, and the Canadian dollar has weakened markedly and bonds have rallied — an appropriate response. The Bank simply believes that its work is done, and needs a lot of convincing to get off the sidelines,” BMO Nesbitt noted.

NBF said that the initial weakening of the Canadian dollar to the Bank’s decision is not surprising, “as market participants are pricing out further rate increases. However, the weakness of the loonie could prove temporary since the Fed should also move to the sidelines with the ongoing slowing down of the U.S. economy.”