By Steve Scherer and David Ljunggren
OTTAWA (Reuters) -The Bank of Canada (BoC) on Wednesday held its key overnight rate at 5.0% as expected and forecast weak growth, while leaving the door open to more rate hikes to tame inflation that could stay above target for another two years.
The bank increased rates 10 times between March 2022 and this July, with inflation peaking at more than 8% last year. Inflation in September dipped to 3.8% from 4.0% in August, and the central bank said it would average 3.5% through mid-2024.
"There is growing evidence that past interest rate increases are dampening economic activity and relieving price pressures," the BoC said in a statement. "A range of indicators suggest that supply and demand in the economy are now approaching balance."
Inflation is expected to return to the 2% target by the end of 2025, slightly later than July's forecast of mid-2025, "but the near-term path is higher because of energy prices and ongoing persistence in core inflation," the BoC said.
The Canadian dollar weakened to a seven-month low at 1.3795 per U.S. dollar, or 72.49 U.S. cents, down as much as 0.4% on the day.
Money markets pared bets for another rate this year, forecasting about an 17% chance for one in December. They had seen about a 19% for a hike on Wednesday.
"Given this sort of dovish tone around the economy, it feels like it would be difficult to see the BoC change their direction quick enough to do anything in December," said Andrew Kelvin, chief Canada strategist at TD (TSX:TD) Securities.
Inflation will decline to around 2.5% in the second half of 2024, with gross domestic product rising at an annualized rate of 0.8% in both the third and fourth quarters of 2023. The BoC in July forecast third-quarter annualized growth of 1.5%.
"Eventually we're getting to that point where the rate hikes (are) going to bite the economy and you are probably going to be close to a recession," said Tom O'Gorman, director of fixed income at Franklin Templeton Canada.
The BoC cut its 2023 growth estimate to 1.2% from 1.8% in July and said 2024 growth would be 0.9%, down from a previously forecast 1.2%. The global economy is slowing and a recent surge in global bond yields is weighing on demand, the bank said.
Wages continued to grow between 4% and 5% annually and core inflation measures have shown "little downward momentum," the bank said, keeping language from previous policy statements warning of another possible rate hike.
"Governing Council is concerned that progress towards prices stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed," the BoC said.
Among the risks cited were oil prices, which are higher than had been assumed in July, and the war in Israel and Gaza, which adds to geopolitical uncertainty, the BoC said.
The central bank is probably done raising rates and will hold them at a 22-year high of 5.0% for at least six months, according to a Reuters poll of economists published on Friday.
Money markets had priced in a 43% chance for a hike on Wednesday before the September inflation data came in. By Tuesday, they had trimmed that to a 20% chance.