Bank of Canada says may have to hike rates

By Louise Egan and Randall Palmer

OTTAWA (Reuters) – The Bank of Canada left its key interest rate at 1 percent on Tuesday as expected but said it may need to start hiking rates due to firmer-than-expected growth and inflation as well as a less hostile global backdrop.

“In light of the reduced slack in the economy and firmer underlying inflation, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 percent inflation target over the medium term,” the central bank said in a statement.

Canada’s economy will return to its full capacity – the speed limit at which it can grow without generating excessive inflation – in the first half of 2013, the bank said, at least a quarter earlier than it previously predicted.

The Bank of Canada has frozen rates since September 2010 after it became the first in the G7 industrialized nations to raise borrowing costs from crisis lows. It had a false start in mid-2011 when it signaled intentions to increase rates, but quickly withdrew that language by September as the European debt crisis exploded.

Its language in Tuesday’s statement was more tentative than in July, saying stimulus “may” be withdrawn whereas in July it said it “will” be withdrawn. It was also cautious in adding that it would weigh the timing and degree of any such withdrawal against developments at home and abroad.

Bank of Canada Governor Mark Carney had adopted a more hawkish tone in the past month and analysts had expected to see that reflected in Tuesday’s statement.

Still, market players had not expected a move by the bank until the second quarter of next year, according to the median forecast in a Reuters poll taken last week.

Economic growth and inflation are both likely to have more momentum than forecast in the January Monetary Policy Report. The bank revised the 2012 growth projection to 2.4 percent from 2 percent but cut the 2013 projection to 2.4 percent from 2.8 percent. It sees growth moderating to 2.2 percent in 2014.

Inflation will soften in the second quarter but then will rise to the bank’s 2 percent target “for the balance of the projection horizon,” the bank said. In January it saw inflation reaching 2 percent in the third quarter of 2013.

(Editing by James Dalgleish)

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