Bank of Canada Governor Mark Carney has announced that interest rates would stay on hold for the time being.

The decision wasn’t a surprise to the market.  Most, if not all, traders were expecting nothing more than an unchanged rate decision.  But, it’s the factors behind the ultimate announcement that is keeping those wanting to go long the Canadian dollar to remain on the sidelines.

Interest rate speculation has supported the Canadian dollar against the greenback in the last several months.  Global investors and traders looking for higher Canadian interest rates were betting that the Bank of Canada would react to beginning of the year growth forecasts that topped 3% – compared to US economic forecasts of about 1-2%.  The sentiment helped to fuel as much as a 6% appreciation in the Loonie against the US dollar this year.

But, now the economic picture has changed.  And, so has the tone of the Bank of Canada.

Rapid growth supported by domestic demand and housing construction has all but dried up.  This has left the nation’s growth rate far below what was expected at the end of 2010.  According to the latest quarterly growth assessment, the Canadian economy actually contracted by 0.4%.  This left the annualized expansion rate lower as well, dropping to 2% from 2.2%.  This is hardly a rate of growth that can spur inflationary concerns, needed to justify a rate hike.

The drop-off in growth has been widely supported by a decline in domestic demand, seen in consumer sales numbers.  Current retail sales growth is on pace to rise by 0.5% for the year, compared to central bank forecasts of a 1.5% advance.

But, it’s not just the domestic economy that has central bankers worried.

According to statements following the Bank of Canada’s decision on September 7th, Governor Mark Carney noted that due to excessive market volatility and the European debt situation “the need to withdraw monetary policy stimulus has diminished.”  This is a sentiment is being shared by other global central banks – most recently by the Reserve Bank of Australia, Sweden’s Riksbank and the Bank of Korea.  All three central banks have noted that excessive market risk and the on-going European crisis is keeping the short term picture of monetary and economic conditions unclear.  This has led to mounting expectations that global central banks will be foregoing inflation management – rather working towards boosting growth.

Traders are expecting just such an outcome with Canada’s central bank as well – with money market indications supporting no BoC rate hikes before Q2 of 2012.

Source:  FXAlliance Charts

Even though expectations for a BoC rate hike may have diminished in the short term, this is not likely to keep the Canadian dollar from appreciating against the US dollar.  With a relatively wide interest rate differential on Canadian assets, and better economic prospects, global investors will continue to seek out the security of the country’s assets.  This will likely keep pressure on the USDCAD currency pair – which remains below parity.

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