Highlights
As expected, the Bank of Canada kept its key interest rate at 3 percent. The Bank surprised analysts after their June 10 meeting by keeping its policy rate unchanged at 3 percent. At the time and in subsequent remarks by Governor Carney, the Bank has expressed some unease about underlying inflation although the risks remained evenly balanced. But although Canadian inflation is tame compared with that in Europe and the U.S., May CPI data show overall inflation at 2.2 percent on the year, up from 1.7 percent in April. And food and energy prices have soared as well. In its Summer 2008 Business Outlook Survey released last week, 36 percent of the respondents expected inflation to rise above 3 percent, the upper end of the target band of 1 percent to 3 percent over the next two years. This was the highest percentage among respondents ever recorded by this survey.

In its statement, the Bank said

"Three major developments are affecting the Canadian economy: the protracted weakness in the U.S. economy; ongoing turbulence in global financial markets; and sharp increases in many commodity prices. The first two developments are evolving roughly in line with expectations in the April Monetary Policy Report. However, commodity prices are continuing to outstrip earlier expectations. This has led to further increases in Canada's terms of trade and real national income, and has altered the outlook for global and domestic inflation.

"Although Canadian economic growth in the first quarter was weaker than expected, final domestic demand continues to expand at a solid pace. The economy is judged to have moved into slight excess supply in the second quarter of this year; excess supply is expected to increase over the balance of the year. High terms of trade, accommodative monetary policy, and a gradual recovery in the U.S. economy are expected to generate above-potential growth starting early next year, bringing the economy back to full capacity around mid-2010. Canadian GDP is projected to grow by 1.0 per cent in 2008, 2.3 per cent in 2009, and 3.3 per cent in 2010.

"Total CPI inflation over the next year is expected to be much higher than projected at the time of the April Report. Assuming energy prices follow current futures prices over the projection period, total CPI inflation is projected to rise temporarily above 4 per cent, peaking in the first quarter of 2009. As energy prices stabilize and with medium-term inflation expectations remaining well anchored, total inflation is then projected to converge to the core rate of inflation at the 2 per cent target in the second half of 2009. Core inflation is projected to remain well contained and broadly in line with earlier expectations, averaging close to 1.5 per cent through the third quarter of this year and then rising to 2 per cent in the second half of 2009.

"The three major developments affecting the Canadian economy pose significant upside and downside risks to the Bank's base-case projection. Weighing the implications of these, the Bank views the risks to its base-case projection for inflation as balanced.

"Against this backdrop, the Bank judges that the current level of the target for the overnight rate remains appropriate. The Bank will continue to monitor carefully the evolution of risks, together with economic and financial developments in the Canadian and global economies, and set monetary policy consistent with achieving the inflation target over the medium term.

"The Bank's detailed projection for the economy and inflation, and its assessment of risks to the projection, will be published in the Monetary Policy Report Update on 17 July 2008."