The Bank of Canada kept the overnight lending rate unchanged at 1 percent on Tuesday, saying the economy is growing faster than it expected.
The bank said the rate is staying at 1 percent to help stimulate the economy, but warned "any further reduction in monetary policy stimulus would need to be carefully considered."
Within two hours of the announcement by the Canadian central bank, the Canadian dollar fell 0.7 cents against the U.S. dollar to 1.04 U.S. cents.
The bank said in a statement that the world economic recovery is becoming more firmly entrenched, citing a surge of investment in Canada and the United States.
The European growth has strengthened, despite ongoing sovereign debt and banking challenges in Portugal, Greece and Ireland, it said. The disasters that struck Japan in March will severely affect its economic activity in the first half of this year and create short-term disruptions to supply chains in advanced economies.
Robust demand from emerging-market economies is driving the underlying strength in commodity prices, which are being further reinforced by supply shocks arising from recent geo-political events.
The bank said that these price increases, combined with persistent excess demand conditions in major emerging-market economies, are contributing to the emergence of broader global inflationary pressures.
Despite the significant challenges that weigh on the global outlook, global financial conditions remain very stimulative and investors have become noticeably less risk averse, the bank said.
Still, the recovery is being slowed by cuts in consumer and government spending.
The bank projected that Canada's economy will expand 2.9 percent in 2011 and 2.6 percent in 2012, and expected the economy will return to capacity in the middle of 2012, two quarters earlier than had been projected in its January report.
The banks noted inflation will increase slightly as the economy picks up.
"While underlying inflation is subdued, a number of temporary factors will boost total Consumer Price Index inflation to around 3 percent in the second quarter of 2011 before total CPI inflation converges to the 2 percent target by the middle of 2012."
The bank noted the persistent strength of the Canadian dollar, which has risen 24 cents against the U.S. dollar since 2009, could create even greater headwinds for the Canadian economy, putting additional downward pressure on inflation through weaker-than-expected net exports and larger declines in import prices.