Bank of Canada maintains key interest rate at 1.25 per cent

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Signs suggest the economy has made some progress in building this capacity, the bank said.

Canada's central bank on Wednesday maintained its key lending rate at 1.25 percent, after the year started with weaker than expected economic growth. The question is not if, but when - and that's anyone's guess.

There's little indication the central bank is in any rush. "We can't be definitive about when, or at what pace".

It is predicting the economy will rebound in the second quarter and post growth of 2.5 per cent.

Most standard frameworks imply that with more slack comes less inflationary pressure, and this seems to be the case for the central bank.

Even the global economy is doing better than forecast in January, the central bank said, making upward revisions to growth and potential output.

-BoC expected to hold rates at 1.25% but surprise hike possible. But the biggest fly in the ointment is where business investment is headed.

The renegotiation of NAFTA prompted by U.S. President Donald Trump and the U.S. trade dispute with China are among the geopolitical risks that could undermine a global recovery and sideswipe Canada, whose economy relies on exports. In the broader report, the central bank said monetary policy is "expected to support economic activity over the projection horizon", which goes through 2020. It also estimated that the two elements could restrain exports by 1.4 per cent over the same time.

The bank reiterated that policymakers "will remain cautious" with respect to future rate moves as it watches to see how Canada's highly indebted households manage the higher borrowing costs.

Any resolution of these issues, while certainly a good thing, would be a double-edged sword from a rate-policy perspective. On the upside, the USA economy could grow faster than expected, boosting demand for Canadian exports.

"This is one of the most exciting BoC meetings in recent memory", says Ian Pollick, head of North American rates strategy at CIBC Capital Markets. However, the expanded capacity would also mean the economy would have more room to grow without fuelling inflation - meaning less pressure to raise rates.

The path of inflation will speak volumes about how much strain there is on capacity, and whether businesses are opening their wallets to give the economy more room to grow. The central bank says investment spending will be "particularly robust" for firms in the service and information technology sectors.

Policy makers were largely sanguine on inflation, which is nonetheless expected to return close to the bank's 2 percent target in 2019 once the temporary impacts dissipate. The unspoken message was that the central bank could live with inflation above the mid-point for a while, too, without feeling compelled to raise interest rates sooner, or faster.

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