As expected, the Bank of Canada left interest rates unchanged Tuesday. The bank’s trendsetting rate has sat at 1% since October following three successive hikes.

Bay Street economists were more interested in the BoC’s accompanying policy statement, which seems to indicate a slightly more cautious central bank.

RBC Economics notes that Tuesday;s policy statement was shorter than the bank’s missive following its October decision. RBC says, “the main differences between the reports were largely factors that argued for the central bank to remain on the sidelines in the near term.”

For example, RBC points out that the BoC acknowledges that second half growth in Canada “appears slightly weaker” than it predicted in its October Monetary Policy Report. The central bank also highlights rising concerns about sovereign debt in Europe, which could continue to weigh on financial markets.

Indeed, National Bank Financial says that the stand pat decision serves as an insurance policy against tail risks, such as European sovereign debt worries. “Although considerable monetary stimulus in Canada continues to fuel the expansion in domestic demand, it makes sense for the Bank of Canada not to act precipitously given the recent developments in Europe and the disappointing performance of U.S. labour markets,” NBF says.

Moreover, the central bank’s view on domestic inflation is that it is “broadly in line” with expectations. “This comment was somewhat surprising since the October core inflation rate jumped to 1.8% from 1.5% in September. In the October Monetary Policy Report, the central bank projected a fourth-quarter 2010 core inflation rate of 1.6%, which would appear difficult to achieve unless the core rate sinks during the final two months of the year,” RBC says.

TD Economics however says that the BoC’s position on inflation is not surprising, given that it still expects moderate economic growth of 2.4% in 2011 and 2.6% in 2012. “At this rate, the Canadian economy will not reach its full capacity until mid-2012, and the unemployment rate will remain a percentage point above its pre-recession peak. Given an expected slow-go recovery it is not surprising the Bank of Canada has chosen to communicate that it believes that inflationary dynamics are largely unchanged,” it says.

The Bank of Canada’s statement also points out the continued strength of the Canadian dollar, TD notes. “The reference to the lofty Canadian dollar solidifies the view that Canadian interest rates can rise only so far above U.S. interest rates — something governor Mark Carney has been communicating for some time now,” TD says.

HSBC Securities (Canada) Inc. says that, ultimately, the BoC has to weigh risking “consumer imbalance and focus on shielding exporters from further dollar strength at the hands of tighter policy or risk hiking rates in 2011 as a means of deterring the consumer binge on cheap credit and potentially sacrificing export growth.”

“Our focus is on consumer behavior and its longer term implications for household imbalance given the current rate profile. In that, our view to a 25 [basis point] rate hike at the March meeting remains intact,” HSBC says. “Although January’s beefier post meeting statement and release of their monetary policy report that will flesh out its economic base case will provide greater clarity as to the Bank of Canada’s intentions going into 2011.”

RBC says it expects evidence of strengthening growth in the United States and Canada, “should eventually start to re-emerge and be sufficiently evident by the second quarter of 2011 to prompt a return to tightening mode. With inflation expected to remain moderate and below the Bank of Canada mid-point of its target range, however, it will allow the pace of tightening to remain gradual. From a current 1.00%, we have the overnight rising 100 basis points to finish 2011 at 2.00%.”

TD Economics sees the BoC waiting until mid-2011, saying, “hiking too soon can be more detrimental to the Canadian economy than keeping rates stimulative for a longer period of time. And with inflationary pressures under wraps, we believe the Bank of Canada has some breathing room to remain on hold until July of 2011.”

“The resumption of the interest rate tightening campaign will remain on hold until the horizon clears on the international front,” NBF maintains, saying that it believes this will occur early in the second half of 2011.

IE