Bank of Canada governor Mark Carney's stand-pat interest rate decision took economists by surprise. (Tom Hanson/Canadian Press)

So much for "no-brainers," "foregone conclusions" and "conventional wisdom." Almost every private-sector economist had predicted that Bank of Canada governor Mark Carney would preside over yet another reduction in the central bank's key overnight interest rate on June 10.

After all, isn't the economy weak? Didn't GDP actually contract in the first quarter of the year? Isn't our biggest trading partner — the U.S. — still embroiled in a housing slump of epic proportions? And didn't the Bank of Canada say in its last rate-chopping announcement in April that further interest rate cuts would be likely?

Well, yes that's all true. So imagine the market's jaw-dropping reaction when Carney decided to jump off the interest rate slide and leave the central bank's key lending rate unchanged at three per cent. This from a central banker who had chopped it by 1.5 percentage points in the previous six months to prevent the economy from sliding into recession.

Dramatic shift in tone

Why the unexpected shift from aggressive rate-chopping mode to stand-pat mode? In a word, inflation.

At least that's the word from the Bank of Canada. The central bank now says the risks of rising inflation are taking precedence over any slowdown in the economy, even though the latest inflation reading puts consumer prices just 1.7 per cent higher in the last year.

So what's the Bank of Canada afraid of? You don't need to look any further than the soaring price of oil. At more than $135 US a barrel, energy costs now pose a threat that the central bank can't ignore. "If current levels of energy prices persist, total CPI inflation will rise above three per cent later this year," the bank said.

That's a noteworthy statement, for the Bank of Canada is traditionally more worried about core inflation, which excludes volatile oil and gasoline prices.

Ted Carmichael, chief economist at JP Morgan Canada, noted that the Bank of Canada "clearly views current upside risks to inflation to be serious enough to stop easing, even though Canada is on track to turn in the worst real GDP growth performance among the industrial countries in [the first half of this year]."

So why is the Bank of Canada not worried about Canada's anemic economic growth?

"I think from the Bank of Canada's perspective, they've lowered interest rates to three per cent and they feel this is enough stimulus in the pipeline," said TD Bank economist Beata Caranci.

The global inflation warpath

Several observers say Carney is now firmly in the growing camp of central bankers who say it's time to get hawkish on interest rates.

Central bankers around the world have recently shifted away from rate cuts, as soaring oil and food costs send inflation rates higher. Bloomberg reports that Vietnam, Brazil, the Philippines and Indonesia all raised their key lending rates in June, with the IMF's global inflation rate poised to hit its highest level in 13 years in 2008.

In early June, European Central Bank president Jean-Claude Trichet said he might need to raise interest rates to fight inflation.

And on June 9 — just one day before the Bank of Canada's non-move — Federal Reserve chairman Ben Bernanke came out with comments that suggested that further rate cuts in the U.S. might be off the table because the risks to growth aren't looming as large any more. "The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so," Bernanke said. So maybe no U.S. recession after all.

The Bank of Canada "seems to be buying into" the Fed's view, CIBC World Markets economist Avery Shenfeld said in a commentary following the Bank of Canada's decision. "There will be armchair central bankers questioning that optimism, particularly in hard hit areas of the Canadian economy centred on manufacturing," he wrote.

Dale Orr, managing director of Global Insight Canada, is one critic who thinks the Bank of Canada should not have strayed from its rate-cutting path. "Growth in Canada has been miserable lately, and it is not going to get much better quickly, yet the Bank's fear of inflation is so great that they won't cut interest rates."

Even those who think the Bank of Canada was right to shift into pause noted that there was no hint that any shift was coming. "Can't quarrel with the decision," said BMO Capital Markets economist Doug Porter. "But the issue here may be on the communication front."

Notwithstanding the failing grade on transparency, the reality of the shift means that the Bank of Canada is officially in "hold-the-line" mode when it comes to interest rates. Many economists see no further interest rate changes until next year, when the Bank of Canada is again expected to be in rate-hike mode.