Canada Unexpectedly Reduces Rate as Inflation Slows

Canada Unexpectedly Reduces Rate as Inflation Slows

Dec. 4 (Bloomberg) -- The Bank of Canada unexpectedly cut interest rates by a quarter-point as the Canadian dollar's rally slows inflation and market ``volatility'' threatens to cool economic growth.

The bank is the second among the Group of Seven to reduce borrowing costs as officials try to keep August's credit collapse from spurring a global economic slump. Governor David Dodge, 64, and his team are also concerned that a stronger local currency is making Canadian products uncompetitive.

``The Bank now expects inflation over the next several months to be lower than was projected,'' the bank said today in Ottawa. The statement also cited ``global financial-market difficulties'' and an ``increased risk to the prospects for demand for Canadian exports.''

Canada's dollar fell and bonds gained after the decision, which pushed the target rate for overnight loans between commercial banks to 4.25 percent. The change, which reverses an increase in July, was anticipated by 12 of 27 economists surveyed by Bloomberg News.

``We are likely going to see another cut,'' said Paul Ferley, assistant chief economist in Toronto at Royal Bank of Canada, the country's biggest lender. ``Going into the fourth quarter, our sense is the growth rate in Canada could get halved'' from 2.9 percent in the third quarter, he said. Ferley predicted no change today.

Today was Dodge's second-to-last decision before he retires Jan. 31 and is replaced by Mark Carney, a 42-year-old former Goldman Sachs Group Inc. investment banker.

Global Response

The U.S. Federal Reserve lowered its benchmark rate twice since August and may do so again next week to ward off a recession in the world's largest economy. Across the Atlantic, the European Central Bank and Bank of England have so far resisted cutting borrowing costs, while trying to push down market lending rates by offering banks extra cash. The Bank of England and ECB meet on Dec. 6.

The Canadian dollar weakened after the announcement to C$1.0128 per U.S. dollar at 10:12 a.m. in Toronto. The currency reached an all-time high of 90.58 Canadian cents per U.S. dollar on Nov. 7.

The currency's advance this year slowed the exports that make up 30 percent of the country's economic output, and pushed the central bank's preferred inflation measure below a 2 percent target. Today's move heeds calls by companies ranging from Montreal jet maker Bombardier Inc. to Vancouver lumber producer Canfor Corp., as well as provincial premiers, who said the dollar's climb was crushing manufacturers.

Subprime Market

The country's trade surplus narrowed to a nine-year low of C$2.7 billion in September, according to Statistics Canada, the same month the currency reached parity with the U.S. dollar for the first time since 1976.

Increases in the consumer price index, minus eight volatile items such as gasoline, declined to 1.8 percent in October, the slowest since June 2006, from 2.5 percent in June. Policy makers use the so-called core inflation rate to gauge future trends.

There are still signs that inflation may quicken. The unemployment rate fell to a 33-year low of 5.8 percent in October and average hourly wages rose 4.1 percent from a year earlier, the third straight month they gained more than 4 percent.

The central bank repeated today the economy is operating beyond full capacity. In recent months it has said the economy is strained by strong domestic demand and high prices for the country's energy and metals.

Carney is scheduled to appear at the House of Commons Finance Committee tomorrow to discuss his views on the currency's advance and other issues, the first-ever appointment hearing for a governor-designate.

BLOOMBERG