USD/CAD

Lower gas prices pulled Canada's annual inflation rate in November down to 1.7%, the first time in 10 months it has been below the Bank of Canada's 2.0% target, underscoring market expectations that imminent interest rate hikes are off the table.

The market had forecast the annual rate would fall to 1.8% from 2.4% in October. November's rate matched the 1.7% seen in January 2018.

The Bank of Canada, which has raised rates five times since July 2017 as the economy strengthened, said earlier this month that economic data heading into the fourth quarter had been weaker than expected.

The central bank is due to announce its next interest rate decision on January 9 and markets expect no change.

Statistics Canada said on Wednesday that gasoline prices fell by 5.4% from November 2017 on lower crude prices and overall energy costs dropped by 1.3% over the same period. In both cases, it was the first year-over-year decline since June 2017.

It also noted that the Bank of Canada's three core inflation measurements came in at 1.9%, the first time they have all been below 2.0% since June 2018.

The drop in the overall annual rate was the sharpest in absolute terms since May 2012, when lower gas prices pulled it down to 1.2% from 2.0% in April.

The Bank of Canada kept interest rates on hold on Wednesday as expected and suggested the pace of future hikes could be more gradual.

The central bank, which has lifted rates five times since July 2017 as the economy strengthens and reaches capacity, repeated that more monetary tightening would be needed to help meet its 2.0% inflation target.

But it noted downward revisions by Statistics Canada to growth figures, together with recent macroeconomic developments, "indicate there may be additional room for non-inflationary growth." This is a sign the economy might not be as close to capacity as previously thought.

Bank of Canada Governor Stephen Poloz on Thursday said the economy was weaker than forecast and predicted low oil prices would cut growth, comments likely to reinforce market expectations that the pace of future rate hikes will ease off.

Poloz, speaking a day after the central bank kept interest rates on hold, repeated that more tightening would be needed to keep inflation on track but added the pace would be decidedly data-dependent.

"It is fair to say that the data released since our October Monetary Policy Report have been on the disappointing side ... the economy has less momentum going into the fourth quarter than we believed it would," Poloz said.

Much of the bank's discussion ahead of the interest rate announcement on Wednesday had been focused on oil, he said. Prices for crude, one of Canada's main exports, are sinking amid a supply glut and this is hurting Alberta, the western province which is home to the domestic industry.

"It is already clear that a painful adjustment is developing for Western Canada and there will be a meaningful impact on the Canadian macroeconomy," said Poloz.

The sector could suffer further harm if trade tensions between the United States and China cut demand, he added.

A slump in oil prices badly hit the economy in 2015, and the damage this time round should be less on a dollar-for-dollar basis, Poloz said, given consolidation in the energy sector since 2014.

Poloz noted that the economy had been operating near capacity for a year, unemployment stood at its lowest level in decades and inflation was on target.

It was natural the bank would seek to raise rates from their current low levels, he said, while acknowledging the potential danger posed by homeowners who had borrowed heavily.

Federal Reserve Vice Chairman for Supervision Randal Quarles said that interest rates are approaching neutral, but the concept of neutral rate can be less useful after the economic conditions become more normal.

Fed officials estimate the neutral rate of interest is from 2.5 to 3.5%, according to Quarles. Asked if Powell meant rate hikes would end sooner rather than later, Quarles said it was not clear about exactly how much further interest rates would rise.

"Where we will end up in that range will depend on the data we receive and our assessment of the performance of the economy over the course of next year," he noted.

Neutral interest rate, a notion that is driving the Federal Reserve' s attitude towards the normalization of U.S. monetary policy, means a level neither stimulative nor restrictive to the economy.

"I think that it can be a useful concept in helping guide monetary policy, but it's not terribly precise," Quarles said.

It may be changing over time, and "its utility as the central organizing thought around how you are conducting monetary policy becomes less."

"Because we are nearing other time where and we're moving back into a normalize monetary policy, that what's really important is that the Fed Reserve have a clearly communicated strategy, about monetary policy and that we execute on that strategy in a way that's predictable and transparent," said the Fed official.

The remarks came after Jerome Powell, chairman of the Fed, said last Wednesday that interest rates are "just below" the broad range of estimates of the level that would be neutral for the economy. Market participants interpreted that as a dovish signal for future rate hikes, compared with his previous remarks in early October that rates were "a long way" from neutral.

Fed raised its benchmark interest rate for the third time this year on September 26 and made the target range between 2% and 2.25%. At that time, Fed policymakers indicated another hike in December, three more in 2019 and probably one more in 2020.

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