The Bank of Canada held its key interest rate steady on Tuesday, as expected, but hinted more strongly than before that it would resume hiking soon as the sturdy domestic economy contrasts with rising risks globally.
Keeping its overnight rate at 1 percent, the bank said core inflation will reach its 2 percent target earlier than it had anticipated and that it sees economic growth speeding up in the second half of this year after a second-quarter slump.
"To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn, consistent with achieving the 2 percent inflation target," the bank said. It removed a reference to stimulus being "eventually withdrawn", used in its May 31 rate statement, suggesting a move was in the not-too-distant future.
Canada's central bank became the first in the Group of Seven advanced economies to tighten monetary policy following the global financial crisis, hiking three times from June to September last year.
It has been on pause since then, but with an eye on threats abroad such as the weakening US economy and the European sovereign debt crisis that threaten to derail growth at home.
The bank's comments were more hawkish than markets expected, pushing the Canadian dollar to a two-month high against the US dollar.
"There is a vague shift in the tone of the statement, toward slightly more hawkish," said Camilla Sutton, chief currency strategist at Scotia Capital.
"So in terms of what the market will price in, (it) will probably pull forward their expectations for interest rate hikes ever so slightly," she said.
The median forecast of 37 analysts in a July Reuters poll was for a resumption of rate increases in the fourth quarter, which means either at the October 25 or December 6 rate decision.
But the bank did flag several caveats to hiking rates and advised that its projections assume that European leaders will be able to contain the sovereign debt crisis.
"A lot of things still have to go right for the bank to be hiking by October but I still think that's still a reasonable call," said Doug Porter, deputy chief economist at BMO Capital Markets.
Overnight index swaps, which trade based on expectations for the key central bank rate, showed investors see 83.7 percent probability rates will stay on hold again in September, down from 91 percent immediately after the statement was released.
The swaps market also showed a slightly increased chance of rate hikes in the remainder of the year, although traders still have not priced in a full 25-basis-point hike until 2012.
The bank maintained its projection that the Canadian economy would return to full capacity by the middle of 2012 and that inflation would remain well anchored.
The economy will grow 2.8 percent this year, revised from a previous forecast of 2.9 percent, the bank said. It kept its 2012 and 2013 growth forecasts unchanged at 2.6 percent and 2.1 percent, respectively.
Total CPI inflation will stay above 3 percent in the near term, largely due to temporary factors. Core inflation is "slightly firmer than anticipated," and "expected to remain around 2 percent over the projection horizon," the bank said.
It said net exports remained weak, reflecting modest US demand and "the persistent strength of the Canadian dollar."
The Canadian dollar strengthened to a session high of C$0.9515 to the US dollar, or $1.0510, from C$0.9548 or $1.0473 shortly before the statement was released.