The Bank of Canada left the key overnight interest rate at 4.25%, as widely expected. The Bank Rate remains at 4.5%.

The central bank’s overnight lending rate has remained at 4.25% since May, following nine consecutive hikes of a quarter of a percentage point.

The Bank of Canada has trimmed its 2006 growth forecast to 2.8% from its earlier forecast of 3.2%. Its 2007 outlook was also reduced to 2.5% from 2.9%. The 2008 forecast remained unchanged at 2.8%.

“This growth profile implies that the small amount of excess demand now in the economy will be eliminated by the second half of 2007,” the bank said.

The overall rate of inflation is still expected to average about 1.5% through to the second quarter of 2007, before returning to the 2% and remaining there through the end of 2008, the bank added.

RBC Capital Markets notes that the statement accompanying the rate decision reiterated the Bank’s view that the “overnight rate is judged at this time to be consistent with achieving the inflation target over the medium term”, which is in line with RBC’s forecast that the Bank will remain on the sidelines for the remainder of 2006. The Bank characterized the risks “around the inflation projection are roughly balanced.”

In its statement the Bank cut its growth forecasts for GDP in 2006 and 2007, RBC notes. Growth in 2006 is expected to be 2.8% compared to the July forecast of 3.2% with real GDP growth of 2.5% forecasted for 2007 rather than the 2.9% in the July Update. The 2008 growth forecast was unchanged at 2.8%. “The as-expected result is unlikely to have a big impact on financial markets although on the larger-than-expected cut to the 2007 growth profile will be marginally negative for the currency,” RBC adds.

Bank of Montreal says that the Bank’s statement supports its view that overnight rates will remain
stable for the foreseeable future. “The Bank’s comments point to steady overnight rates at the next fixed announcement date on December 5, and likely beyond. We expect rates to remain stable through 2007,” BMO says. “That said, if growth in demand comes in weaker than expected, or growth in productivity is stronger than expected — thus pushing the unemployment rate materially higher — then the Bank would likely need to reduce rates to prevent inflation from falling below the target.”

National Bank Financial says that the Bank’s statement is more hawkish than it expected. “We thought that the Bank would acknowledge the economy was operating at a slightly lower level of utilization given lacklustre growth in GDP in both Q2 and Q3. The only way the Bank could avoid making such a statement was to reduce the growth rate of potential GDP and this is what they opted to do.”

“So even though the Bank has revised down significantly its growth profile for the Canadian economy, our central bank is not in any hurry to make rate cuts,” NBF says. “For the time being, they are largely maintaining the view that they have held since last April that the risks to the inflation outlook are balanced. The Bank will have a lot of explaining to do when it releases its MPR on Thursday.”

TD Bank agrees that the Bank is likely on hold for the time being. “Taking both the economic growth and inflation forecast together, the Bank reaffirmed their message that the current level of the overnight rate is consistent with ensuring that inflation remains on target over the medium term. So despite the fact that the outlook for economic growth has been downgraded, the Bank has signaled its intention to remain on hold for the foreseeable future,” it says.

“As the future of monetary policy in Canada increasingly becomes a tug-of-war between domestic resilience and weakness in net trade, we feel that the slowing in the U.S. economy will likely tip the balance, translating to a modest 50 basis points of rate cuts over the first half of next year,” TD predicts.

RBC Economics expects the Bank to hold the policy rate steady for the remainder of 2006 with a rate cut likely in late 2007 based on its expectation that the economy will grow at a lower-than-trend rate in the second half of 2006 and at about its potential pace in 2007. “A softer U.S. economy is likely to continue to see export growth lag imports, producing a continued drag on the pace of economic expansion from the trade sector for the remainder of 2006. The domestic economy is expected to continue to grow at a decent pace,” it says.

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On Thursday, the central bank will offer more details on its revised economic outlook when it releases its semi-annual monetary policy report. The bank’s governor, David Dodge, will also speak to reporters that morning and appear before the House of Commons finance committee in the afternoon.

The next scheduled date for announcing the overnight rate target is December 5.