The Bank of Canada today left its key interest rate unchanged at 4.25%, as expected.

The overnight rate has remained at 4.25% since May 24 when the central bank bumped up the rate by one-quarter of a percentage point.

Following today’s announcement, Bay Street economists remained divided over the future of the cnetral bank’s monetary policy.

Bank of Montreal reports that the accompanying statement said that, although economic growth in the final quarter of 2006 may come in “a little weaker than previously expected,” policymakers continue to believe that the current level of interest rates is “consistent with achieving the inflation target over the medium term” and that the risks to the inflation outlook are “roughly balanced.”

“The Bank believes the economy retains underlying strength, supported by strong global growth, high commodity prices, and sustained employment gains,” BMO says. “The Bank’s comments point to unchanged policy at the next fixed announcement date on January 16, and likely beyond. We continue to expect rates to remain stable through 2007.” However, a number of other economists expect rate cuts to happen some time in 2007.

TD Bank says that the key messages established over the last few FAD’s were maintained in today’s announcement. “Firstly, the current level of the overnight rate was judged to be at a level consistent with returning inflation to the 2% target over the medium term. Secondly, the risks surrounding the outlook for inflation remained in balance.”

“An argument can be made, however, that an acknowledgement of a greater downside risk will be warranted in the future,” TD suggests, noting that there are signs that future inflationary pressure may be dissipating, and economic growth has slowed.

“Despite a weakening economy, the Bank is waiting for more evidence before changing their view of the risks,” TD observes. It predicts that the Bank will likely not change rates at its next meeting in mid January, but, “we feel the evidence of mounting economic slack will cause the Bank to start shifting the balance of risks to the downside – priming the market for the first of two 25 basis point cuts due two meetings later in April.”

National Bank Financial says that today’s announcement constitutes the first step before considering an easing bias. “Even though the Bank kept rates unchanged this morning and maintained that its growth outlook is essentially unchanged from October, the most important change in today’s press release is that our monetary authorities no longer refer to the economy as operating above capacity.”

“This is an important development as it is the first step for opening the door to fine-tuning of monetary policy in 2007 (read rate cuts),” NBF suggests. “For the moment, the only thing that is keeping the bank married to its forecast is the state of the Canadian and U.S. labour markets where employment growth has been sustained. Should job creation take a downturn, we would anticipate the Bank of Canada to alter its risk assessments of the economy and its inflation outlook as soon as its January 18 MPR update. For now, we still think that a March rate cut is the most likely scenario.”

Economists at RBC also see rate cuts next year, but much later. RBC expects the Bank to hold the policy rate steady until late 2007 when it believes a rate cut is likely. It notes that core inflation moved above the mid-point of the Bank’s 1% to 3% target in September and is likely to remain elevated into early 2007. “Rising costs associated with housing, a tight labour market and high capacity usage keep the risks to the near-term inflation outlook biased to the upside,” it says. “In its October Monetary Policy Report, the Bank forecasted that the core inflation rate would likely to remain above 2% until the middle of 2007, setting the stage for the Bank to hold rates steady, unless growth slows significantly relative to their 2.5% forecast for the first half of next year.”

The Bank of Canada’s next scheduled date for announcing the overnight rate target is Jan. 16, 2007.