Bank of Canada Remains on Hold

• The Bank of Canada held the target for the overnight rate at 0.25%, and reiterated its commitment to keep rates unchanged through the second quarter of 2010.
• The announcement was largely uneventful, with the Canadian economic outlook relatively unchanged and no new news on the direction of monetary policy.
• TD Economics continues to believe that the Bank of Canada will remain on hold beyond its conditional commitment of June 2010, and the first rate hike will not come until the fourth quarter.

As widely expected, the Bank of Canada held the target for the overnight rate at 0.25%, and reiterated its commitment to keep rates at their effective lower bound through the second quarter of 2010. The Bank of Canada's decision is consistent with the significant amount of slack accumulated over the economic downturn - with the output gap estimated at -3.25%, and inflation that has been roughly in-line with the Bank's expectations. The announcement was largely uneventful, and offered no new news on the direction of monetary policy.

The bank noted that while the Canadian recovery got off to a slow start, economic growth will be more pronounced in the fourth quarter of 2009. They didn't provide an estimate, but consensus forecast is that the economy grew in the range of 3.5-4% in that quarter. But this will not be enough to sway the Bank of Canada off the sidelines. The Bank acknowledged that the global recovery has been stronger than originally expected, but they believe that the Canadian economic recovery still hinges on the extraordinary stimulus stance of fiscal and monetary policy- which suggests that premature rate hikes could derail economic growth. Moreover, despite the stronger than expected performance in the near-term, the Bank of Canada's economic forecast remained relatively unchanged from October's Monetary Policy Report(MPR). The Bank left their forecast for 2010 roughly unchanged at 2.9% and they nudged their 2011 real GDP growth forecast up to 3.5%, from 3.3% in October's MPR. The inflation outlook was unchanged, with the Bank expecting inflation to remain below its 2% target until the third quarter of 2011.

The Bank of Canada maintained that the risks to the outlook continue to be those outlined in the October MPR, with the upside risks being a stronger rebound in global growth and Canadian domestic demand. The downside risks are continued U.S. weakness and the negative implications of a strengthening Canadian dollar. Unlike the Bank of Canada, we continue to put a little more weight on the downside risks, and our forecast for GDP growth of 2.7% in 2010 and 3.0% in 2011 is slightly more pessimistic than the Bank's view. Our forecast is consistent with an output gap that closes - and with inflation reaching the Bank of Canada's 2.0% target - in the third quarter of 2012, a year later than the Bank of Canada's estimate. There is no disputing that interest rates have only one direction to go, and that's up. However, the large amount of slack, and the slow absorption of that slack, means that the Bank of Canada can take its time with monetary policy. As such, we continue to believe that the Bank of Canada will remain on hold beyond its conditional commitment of June 2010, and the first rate hike will not come until the fourth quarter.

TD Bank Financial Group

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