Bank of Canada says inflation surge temporary, warns on growth

By Randall Palmer and David Ljunggren OTTAWA (Reuters) - Shrugging off a recent surge in inflation as temporary, the Bank of Canada warned on Wednesday the country's economy does not yet have enough steam to grow without the bank's help and said it could just as easily cut interest rates as raise them. The central bank, as expected, kept its key overnight rate at a low 1 percent, the stimulative level at which it has been for 46 months. But Governor Stephen Poloz made clear he is worried about downside risks to the economy after "serial disappointment" with global growth in recent years. "Monetary conditions today are highly stimulative and it's evident that we don't have a process of natural growth in the economy yet," he told a news conference. The central bank said it would keep its policy stance "neutral", meaning its next move could be either a tightening or easing. Poloz acknowledged higher-than-expected inflation but said underlying price pressures were low and emphasized how important the level of the Canadian dollar is to a recovery in exports, which in turn are critical to the overall economy. "It is obviously a very important variable, because it feeds directly into the export sector," he said. "The export sector is a really important part of how we get home. Right now, we do not have a sustainable growth picture in Canada." Many analysts have said Poloz, who was previously head of government agency Export Development Canada, wants a relatively weak currency to stimulate exports. Poloz has repeatedly pointed out the central bank has a mandate to target inflation and not the currency. Still, the Canadian dollar touched a 3-1/2-week low after the Bank of Canada published its policy statement. [CAD/] "The statement reinforced the bank's dovishly neutral stance by playing up the downside growth risks," said Sal Guatieri, senior economist at BMO Capital Markets. "The bottom line is, unless the Canadian dollar weakens and the U.S. economy strengthens, Canada's economy probably won't meet the Bank of Canada's forecast." The central bank's quarterly Monetary Policy Report (MPR) trimmed its Canadian economic growth forecast for 2014 to 2.2 percent from 2.3 percent and its 2015 forecast to 2.4 percent from 2.5 percent. The MPR had numerous references to the lower Canadian dollar. It said, for example, that the level of the currency had reversed a small portion of the past deterioration in Canada's competitiveness. And it said that, combined with strengthening foreign activity, the lower Canadian dollar should support moderate export growth. The central bank did omit language it had used in its June rate statement that said the downside risks to its inflation outlook remained important, an acknowledgement that overall inflation hit 2.3 percent in May and that core inflation at 1.7 percent was also higher than forecast. The bank's target is 2 percent. "The downside risks to inflation associated with a below-target starting point have clearly diminished," Poloz said. The overall tenor of the central bank's statement and accompanying MPR, however, was to emphasize excess capacity in the economy. It said the persistent slack in the economy, combined with intense retail competition, would keep inflation pressures muted. Recent higher inflation has resulted from higher energy prices, the fall in the Canadian dollar and sector-specific shocks such as costlier meat, "rather than due to any change in domestic economic fundamentals," the bank said. Demonstrating its disappointment with economic growth, the central pushed back yet again, to mid-2016, its expectation for the economy reaching full capacity and core inflation rising to its 2 percent target. It said that total inflation would dip back below 2 percent in the second quarter of 2015 and rise to the target again only in the first quarter of 2016. (Additional reporting by Andrea Hopkins, Solarina Ho, Cameron French, Alastair Sharp, Leah Schnurr and John Tilak in Toronto; Editing by Peter Galloway and Jeffrey Hodgson)