-BOC Will Expect Improved Growth But Slack Remaining

By Courtney Tower

OTTAWA (MNI) - In a one-two performance this week, the Bank of Canada likely will maintain its 0.25% policy interest rate on Tuesday and re-commit on Thursday to holding that economic stimulus steady for at least five months more.

Economists are unanimous in expecting the central bank tomorrow to hold the target for the overnight rate at the rock-bottom 0.25% it set last April in order to provide stimulus in recession. Most expect only a slight tweaking of the announcement text, to express a growing confidence in Canadian economic recovery. Despite the brightening outlook, most believe the Bank will hold to its conditional commitment to maintain the 0.25% rate at least through June.

The condition set by the Bank is that any marked change in inflation expectations could cause an earlier rate rise. The Bank has indicated several times that, although some sectors are improving, there remains much slack in the economy and inflation is not expected to become a dangerous prospect any time soon.

The Bank will produce its quarterly Monetary Policy Report on Thursday, an extended analysis of the state of the world and Canadian economies. Most expect it to show greater confidence that Canadas economic recovery is progressing on several fronts. But on balance the Bank will stand fast on the rate "until mid-year given still-substantial economic slack," CIBC chief economist Avery Shenfeld says in a research note.

Inevitably, the Bank will start to increase its rate, but not soon, most believe. That likely will happen "sometime this year," says Eric Lascelles, chief rates strategist for TED Securities. However, he adds, "it is simply premature for the fireworks to start quite yet."

There is a strong upsurge in sales of existing housing and in homebuilding starts, an upsurge which in fact is driving economic recovery in Canada, but the Bank has two answers for that:

--Canada is well off any dangerous housing "bubble" occurring, with prices still generally affordable, with a conservative mortgage lending culture having kept too many Canadians from being over-extended, with the provision of housing still off expectations of demographic need.

--But even if there were a "bubble," the Bank will not change its key rate, its inflation-controlling monetary policy tool, in order to attack a specific sector problem. There are other governmental tools of regulation and control by federal agencies and departments to handle that, BOC Deputy Governor Timothy Lane said in a speech read for him last week.

There is a trade-off that the Bank will not enter, Lane made clear, saying: "If the Bank were to raise interest rates to cool the housing market now -- when inflation is expected to remain below target for the next year and a half -- we would, in essence, be dousing the entire Canadian economy with cold water, just as it emerges from recession."

The Bank admits concern about rising household indebtedness, in this prolonged period of very low commercial interest rates stemming from the Banks benchmark rate. But the Bank at the moment appears to want to talk that down -- it has urged both consumers and lenders to be more prudent.

As to the inflation rate, the Bank's over-riding concern, Statistics Canada reports inflation data, the Consumer Price Index for December, on Wednesday, in between Tuesdays rate announcement and Thursday Monetary Policy Report. The total CPI for November was 1.0% and the core was 1.5%. Analysts have differing assessments of core and total CPI for December, though a median seems to be for the annual total CPI rising to 1.6% , a considerable leap, and annual core to 1.7%, a more modest increase.

All 10 economists gathered together last week by the C.D. Howe Institute, an economic think tank in Toronto, voted that the Bank should hold its rate at 0.25%, and nine recommended the same for the March 2 setting. They accept that the rate will stay through June but all would raise it at the July 1 setting, to a consensus level of 0.75%. They as a group would recommend a 2.0% rate in January, 2011.

This group, and most economists, see slow growth for Canada this year because of two main "headwinds" -- a continuing sluggish United States economy, which takes about 75% of Canadas exports, and a continuing strong Canadian dollar, which again slows exports.

** Market News International Ottawa **