The Bank of Canada left the overnight interest rate unchanged at three per cent on Tuesday, suggesting inflation in coming months could be worse than previously expected.
The bank decided on the measure despite fears of an economic slowdown that could have justified a slight rate cut. The decision was widely expected among members of the financial community.
The commercial banks' prime lending rate, seen as a benchmark for setting loan costs, will hold at 4.75 per cent.
The bank believes high energy prices will push inflation higher than four per cent by the first quarter of 2009 -- a percentage point higher than previously forecasted and one of the highest rates in years.
By keeping the rates at current levels, the bank says it can force inflation to return to the two per cent target midway through 2009.
It also reversed brighter predictions of Canada's economic growth, suggesting a mere one per cent gross domestic product increase this year and 2.3 per cent next year. In April the central bank had predicted 1.4 per cent growth this year and 2.4 per cent next year.
"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 bank said in a statement released Tuesday.
"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."
Tuesday's announcement came on a day that began with the Toronto Stock Exchange dropping more than 400 points after opening, and at a time when the U.S. Federal Reserve and the Bank of England are both keeping interest rates in a holding pattern.
"They kept rates unchanged at their recent decisions as they try to balance weak economic growth over the forces of inflation," Business New Network's Michael Kane told CTV's Canada AM on Tuesday. "It's a tight rope to walk. Canada currently has the most benign inflation rate in the Group of Seven industrialized nations."
Bank of Canada Governor Mark Carney recently said he's worried high oil prices are shocking the economy and driving prices up.
Economists with the United Steelworkers union and the Canadian Labour Congress had both called for an interest-rate cut to help manufacturers deal with the strong Canadian dollar.
Meanwhile, the CD Howe Institute, a right-leaning think tank, wanted the bank to increase its overnight interest rate by one-quarter of a point.
Since December, the bank had been steadily cutting the interest rates, enacting a reduction of 1.5 percentage points since December. It stopped in June, warning that inflation has become a rivalling concern.
The Bank of Canada's next scheduled interest rate announcement is set for Sept. 3.
With files from The Canadian Press
