By David Ljunggren
OTTAWA (Reuters) - The Bank of Canada kept interest rates on hold on Wednesday as expected and suggested the pace of future hikes could be more gradual, knocking a cent off the Canadian dollar and slashing market expectations of another increase next month.
The central bank, which has lifted rates fives 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 percent 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.
The Canadian dollar fell sharply and by 10:30 a.m. ET (1530 GMT) was trading at C$1.3393, or 74.67 U.S. cents, down from C$1.3275 to the greenback, or 75.33 U.S. cents.
As recently as last month markets had fully priced in another rate increase on Jan. 9. Since then, prices for oil - one of Canada's biggest exports - have fallen, and recent data showed the economy shrank in September.
"The next move should be higher. But I think this clearly lengthens the time frame that should reduce the odds of a January hike substantially," said Andrew Kelvin, senior rates strategist at TD Securities.
Market expectations of an interest rate hike next month, as reflected in the overnight index swaps market, were around 35.5 percent shortly after the announcement.
The bank's overnight interest rate stays at 1.75 percent, still well below the "neutral" rate of 2.5-3.5 percent where monetary policy is neither stimulative or accommodative.
"Governing Council continues to judge that the policy interest rate will need to rise into a neutral range to achieve the inflation target," said the bank, predicting inflation in coming months will ease more than previously forecast as gasoline prices fall.
The appropriate pace of future hikes would depend on the effect of higher rates on consumption and housing, global trade developments, the oil price shock, the evolution of business investment "and the Bank's assessment of the economy's capacity", it added.
The bank "will reassess all of these factors" in projections for the economy that it is due to release on Jan. 9, it added.
"I think longer run, they're still committed to getting back toward a neutral policy rate, but they're inserting some pause language along that path, that tamps down the expectations for a January hike," said Derek Holt, vice president of capital market economics at Scotiabank.
The central bank said the Canadian economy had grown in line with expectations in the third quarter but data suggested less momentum going into the fourth quarter.
Weaker oil prices and associated production cutbacks mean activity in the energy sector is set to be materially weaker than expected.