By Randall Palmer and Louise Egan
OTTAWA (Reuters) - The Bank of Canada said on Wednesday it will hold its benchmark interest rate steady at 1 percent while the economy remains fragile and inflation stays low, but that it still sees rates rising if the economy performs in line with its expectations.
The policy announcement, the first under new Governor Stephen Poloz, delivered roughly the same message as those offered by his predecessor, Mark Carney, over the past year: it is likely just a matter of time before borrowing costs start to rise.
But Poloz, who took over in June, was more explicit in stating that the continuation of steady rates depends on three key factors.
"As long as there is significant slack in the Canadian economy, the inflation outlook remains muted, and imbalances in the household sector continue to evolve constructively, the considerable monetary policy stimulus currently in place will remain appropriate," Poloz told a news conference announcing the bank's decision.
"Over time, as the normalization of these conditions unfolds, a gradual normalization of policy interest rates can also be expected, consistent with achieving the 2 percent inflation target."
The Canadian economy has struggled to stay on a growth track after a relatively speedy recovery from the world economic crisis. Inflationary pressures remain muted.
The bank did not provide specific thresholds that could trigger a rate increase.
Some economists had raised the possibility that Poloz would drop any mention of future rate hikes in a more dovish stance than Carney had taken. Following the statement, traders eliminated their already minuscule bets on a rate cut in September, and also reduced their bets on a rate hike in October and December.
"They tweaked - very, very slightly - the eventual tightening bias, but not in any meaningful way, I don't think," said Mark Chandler, head of fixed income and currency strategy at the Royal Bank of Canada.
"Overall, I think it was quite cautious. I'd hate to paint it specifically dovish or hawkish."
The Canadian dollar weakened to a session low against the U.S. dollar after the statement, sliding to C$1.0445 versus the greenback, or 95.74 U.S. cents. But it quickly regained most of the lost ground.
The central bank has held its overnight rate at 1 percent since September 2010, the longest period between rate changes since the 1950s. Since April 2012 it has been hinting at rate hikes to come, making it the only central bank in the Group of Seven major economies to have a hawkish bias, albeit a mild one.
Market players don't expect a move until the fourth quarter of 2014.
"I think the bank has been pretty clear on what conditions will get them to tighten. Ours, and others' views are so far down the line, it's just a matter of whether the economy behaves or not," said Doug Porter, chief economist at BMO Capital Markets.
HIT FROM FLOODS, STRIKE TEMPORARY
The bank cut its forecast for second-quarter growth sharply - to 1 percent from 1.8 percent - largely due to the impact of catastrophic flooding in Alberta and a strike by construction workers in Quebec. But it said third-quarter growth would more than compensate for that decline. It forecast third-quarter growth of 3.8 percent, up from its previous estimate of 2.3 percent.
That meant the volatility of the two quarters would not play into its policy choices.
The Alberta flood will cut 0.7 percentage points from second-quarter annualized growth, while the Quebec strike will cut 0.6 points, the bank estimated. Rebuilding in Alberta will boost growth by 1 percentage point in the third quarter, while the end of the Quebec strike in early July means third-quarter GDP will get a 0.8 point lift.
The bank said the economy will grow 1.8 percent this year, up from its previous estimate of 1.5 percent. Growth will come in at 2.7 percent in both 2014 and 2015, it estimated.
The overall growth outlook is little changed from the bank's April forecast, and the bank continues to expect the economy to return to full capacity and inflation to rise to its 2 percent target by mid-2015.
One key change in language from previous statements is that the bank no longer referred to the "persistent strength of the Canadian dollar," reflecting a weakening of the currency since the Monetary Policy Report the bank released in April.
"In general, we would prefer not to offer a running commentary on the dollar in any case," Poloz said.
(Editing by Peter Galloway and Janet Guttsman)