Canada's central bank did the expected on Tuesday as it held the line on interest rates for a seventh consecutive decision date, but dropped hints that inflation could become a problem.

The Bank of Canada kept the overnight rate — what big banks charge each other for overnight loans — steady at 4.25 per cent. 

The rate has not moved since May 24, 2006, when the Bank of Canada raised it by one-quarter of a percentage point.

In the commentary accompanying the rate decision, the bank said food and gasoline prices have recently risen more than expected.

The bank said core inflation, which factors out volatile components including some energy and foods costs, is projected to decline to two per cent by the end of 2007.

Overall inflation is projected to rise above the two per cent inflation target in the second half of this year, before returning to the target by mid-2008.

In March, both the overall and core inflation rates came in at 2.3 per cent.

Despite the bank's talk on inflation, reaction from the markets was muted. The Canadian dollar traded lower on foreign exchange markets, slipping 0.02 of a cent to 89.07 cents US.

The central bank also said that economic growth it expected to come in at 2.2 per cent in 2007 and 2.7 per cent in both 2008 and 2009.

The bank will expand on its outlook for the economy when it releases its monetary policy report on April 26 and bank governor David Dodge holds a press conference.

U.S. economy expected to struggle

David Tulk, senior economist at TD Bank, said his organization is betting, along with the Bank of Canada, that the U.S. economy will continue to struggle over the next few quarters, holding growth in Canada to below its potential rate and leading to a gradual easing in the core inflation rate.

"As such, the greatest likelihood remains no change in the overnight target rate through the end of 2007, although in light of the [Bank of Canada's] concerns about inflation, one certainly cannot dismiss the possibility of a rate increase," Tulk said in a commentary.

BMO Capital Markets economist Douglas Porter said that unless core inflation or growth sprints higher, the central bank is likely to stay on hold until the U.S. economy stabilizes and begins picking up again, which may take until late this year.

"We continue to believe the next move will be a modest rate hike in early 2008, and there's nothing here to deflect that view," Porter said.