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Bank of Canada cuts growth forecast, warns again of higher rates

OTTAWA (Reuters) - The Bank of Canada on Wednesday chopped its economic growth forecast for the country and left interest rates unchanged but still insisted the next move in interest rates would likely be a hike.

In the last Monetary Policy Report before Governor Mark Carney leaves for the Bank of England, the Bank of Canada sharply downgraded growth expectations for the first and second quarters to below its 2.1 percent estimate of potential growth, meaning slack was continuing to grow.

It cut its prediction for 2013 annual economic growth to 1.5 percent -- matching this week's International Monetary Fund forecast -- from the 2.0 percent it saw in January, and hopes for 2.8 percent growth in 2014.

Nonetheless, as it has over the past year, the central bank warned of the prospect of higher interest rates down the road.

"With continued slack in the Canadian economy, the muted outlook for inflation, and the constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required..." the central bank stated.


The bank's governing council reached its interest rate decision on Tuesday and released it on Wednesday with its quarterly Monetary Policy Report.

In the report, the Bank of Canada figured the economy's spare capacity grew to 1-1/4 percent in the first quarter, from the 1 percent it saw in January for the fourth quarter of 2012.

As a result, it will take longer for the economy to hit full capacity and for total and core inflation to rise to the bank's 2 percent target. It now sees this happening by mid-2015, whereas in January it had predicted the second half of 2014.

"It likely pushes (an interest rate hike) out even further. It's likely we won't have higher rates in Canada until well into 2015," said Bank of Nova Scotia chief currency strategist Camilla Sutton.

Sal Guatieri, senior economist at BMO Capital Markets, said the market had already pushed out its expectations for the next hike. "We still look for the bank to remain on hold until the second half of next year," he said.

The culprits for the lower growth this year are downward revisions to growth in government spending, more contraction in housing than forecast, and less-than-expected business investment. It saw signs that factors weighing on business investment were "likely to persist for some time."

Concern over housing is one reason Carney has not dropped the bank's year-long tightening bias as some economists have suggested. But the insistence that the next movement in interest rates is likely up rather than down has also boosted the Canadian dollar.

The bank said the currency's persistent strength was influenced by safe-haven flows and spillovers from global monetary policy, and this continued to restrain export growth.

Despite the export troubles, one bright prospect is the U.S. housing recovery, which the bank projects will boost Canadian export growth by 1 percentage points per year.

Canada has been an outlier among major developed economies, eschewing the unconventional quantitative easing used by the U.S. Federal Reserve, the Bank of England and now the Bank of Japan.

Before Wednesday's statement, global forecasters pushed back their forecasts for the Bank of Canada's next hike to the third quarter of 2014 from the first quarter in a poll in February.

Yields on overnight index swaps, which trade based on expectations for the policy rate, showed traders slightly scaled back their bets of a rate cut later this year.

The Canadian dollar moved was little changed after the announcement at C$1.0265 to the U.S. dollar, or 97.42 U.S. cents, but weaker than Tuesday's North American close of C$1.0205, or 97.99 U.S. cents.

Canadian inflation has long been below the 2 percent target -- overall annual inflation was 1.2 percent in February. The Bank of Canada said that in addition to spare capacity, inflation was subdued by competitive pressures on retailers.

Among those competitive pressures, it noted the expansion of big-box stores, the arrival of large U.S. retailers, and increased online and cross-border shopping, stimulated by the strong Canadian dollar.