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The Bank of Canada held its benchmark interest rate steady on Tuesday, as widely expected, as the global economy remained fragile amid debt problems in Europe and the United States.

But the central bank hinted higher borrowing costs could be coming sooner than later if the domestic economy maintains steady growth.

The bank's lending rate has been at a near-historic low of one per cent since last September in an effort to spur economic growth following the downturn.

"To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn," the Bank of Canada said in its interest rate statement. "Such reduction would need to be carefully considered."

Avery Shenfeld, chief economist at CIBC World Markets, "may be nudging the market into pricing greater odds of at least a modest dose of interest rate hikes before year end."

"It dropped the word 'eventually' in reference to the need for rate hikes ahead, and while saying some of the pressure on core inflation is 'temporary,' it also attributed some to 'more persistent strength in the prices of some services'."

The Bank of Canada on Tuesday also revised its economic growth outlook for 2011 to 2.8 per cent, down from the previous estimate of 2.9 per cent. Left unchanged were growth forecasts for 2012, at 2.6 per cent, and 2013, at 2.1 per cent.

"Of course, the troubles abroad and challenges to net exports kept the bank from hiking as early as today, and it is still assuming a resolution of the eurozone debt issues," Shenfeld said. "But signs of better growth in the U.S. and Canada in the second half would clearly be enough to tip the bank into hiking, and we should have enough of that evidence on hand by October."

Still, some economists have pushed back the possibility of a rate hike until early next year due to continuing uncertainty outside Canada's borders.

"Weighing-in on the stand-pat side, the U.S. economic soft patch is dragging on, as we count down to potential 'credit events' on both sides of the Atlantic," said BMO Capital Markets economist Michael Gregory.

"Pulling on the tighten-soon side, Canadian domestic demand performance in Q2 might not be as bad as initially posited, owing to a surprising surge in home construction, while the output gap could be smaller, and closing quicker, if the latest Business Outlook Survey is any guide."

The Bank of Canada is expected to provide more details on its economic outlook on Wednesday (tomorrow) when its releases its Monetary Policy Report.

Source: Financial Post

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