A significant slide in a preliminary measure of China’s factory activity for September is getting more attention than usual because Janet Yellen mentioned concern about China’s economic outlook as a reason for Fed caution. This reduces the odds of a rate hike in October.

Data released in China last night showed that companies are struggling across the board. Subindexes for output, new orders,  new export orders, employment, prices and inventories all weakened more than expected. The preliminary Purchasing Managers’ Index from Caixin Media and Markit Economics posted its lowest reading in 6-1/2 years. In consequence, Asian stock markets sold off sharply.

The collapse in new export orders suggests that global trade is facing headwinds–a concern for both the Canadian and U.S. economies. As the second largest consumer of energy, oil prices are also vulnerable to what has been a sustained slowdown in China. Beijing will clearly miss its roughly 7 percent target growth rate this year, the slowest pace in 25 years.

The two drivers of growth in the past, manufacturing and fixed-asset investment, have slowed sharply this year. Investment in real assets, such as residential and commercial real estate construction, rose at its slowest pace in 15 years. This has reduced Chinese demand for industrial materials, putting downward pressure on prices.

Excess capacity across a number of industries in China, as well as weakness in domestic and international demand, are major challenges facing Chinese factories. Finished goods inventories rose sharply, pointing to a further drag on industrial production in the near term. The TSX materials sector is down more than 28 percent year-over-year and the TSX energy sector has plummeted more than 37 percent over the same period.  Alberta and Newfoundland are in recession and Saskatchewan’s economy has weakened. Continued weakness in China spells further bad news for this part of the Canadian economy, pointing towards further weakness in the Canadian dollar and potential further rate cuts by the Bank of Canada.

The Fed’s decision to hold US interest rates steady at near zero Thursday is good news for Canadians with a long-term mortgage. With mortgage rates for home loans with longer terms affected by US bonds, which are tied to US interest rates, any increase will begin to have an effect down the line. Shorter-term mortgage rates often follow the trend. However it is still possible that there will be an increase of 25 basis points in the Fed’s rate this year with a full 1 per cent added in 2016, making this month’s freeze just a temporary reprieve.

The Fed kept the overnight rate unchanged today, choosing to delay an increase owing to stubbornly low inflation, an uncertain outlook for global growth and recent financial market volatility. It appears that recent losses in China’s equity markets reflect deeper worries over growth prospects for the world’s second largest economy. Slowing growth in China has helped to trigger a dramatic drop in commodity prices, especially oil, which has put further downward pressure on U.S. inflation.

Currently, inflation in the U.S. over the past twelve months is only 0.3 percent, well below the Fed’s target of 2 percent. Much of this is owing to the strengthening in the U.S. dollar and falling commodity prices. Also, despite tightening labor markets, wages gains have remained extremely muted.

By holding the benchmark federal funds rate at zero to 0.25 percent, policy makers revealed their continuing uncertainty that inflation has not moved back to their 2 percent target, despite gains in the labor market. The Committee expects inflation to remain low for many months.

Federal Open Market Committee (FOMC) members revised down their expectation of unemployment this year and next to a few basis points below the current level of 5.1 percent. Inflation expectations were revised down, as were projections of the federal funds rate even though growth is expected to perform well.

Most participants expect the Fed to raise interest rates this year, although four Committee members expect the first increase to be delayed to 2016. Richmond Fed president Jeffrey Lacker dissented with the Committee’s decision, saying he preferred to raise the target rate by 0.25 percentage points now.

Concern was expressed regarding global economic uncertainty. Clearly, the slowdown in China has caught the Fed’s attention. Headwinds from abroad are affecting the Fed’s forecast. The federal funds rate is not expected to return to “normal” levels until the end of 2018. So when interest rates do rise, they will do so only gradually.

The median of the Fed’s long-term forecast was lowered to 3.5 percent from 3.8 percent in June. The Fed is forecasting a federal funds rate of 0.4 percent for 2015, 1.4 percent in 2016, 2.6 percent in 2017 and 3.4 percent in 2018, which all are lower than the central bank saw in June. The central bank projected less inflation, trimming its forecast for inflation this year, 2016 and 2017, and not seeing inflation reach the 2 percent target until 2018. At the same time, the Fed got more optimistic on the unemployment rate, lowering its projections for 2015, 2016, 2017 and the longer term.

This is good news for Canada where the economy is  much weaker than in the U.S. and where the Bank of Canada is at least a year away from tightening. Chairman Yellen mentioned Canada specifically in her press conference, suggesting that the slowdown in Canada arising from the oil price rout is important as Canada is “an important trading partner” with the U.S. Clearly, interest rates will remain low for a long time and when they do rise, they will do so only gradually.

As expected, the Bank of Canada refrained from cutting interest rates at today’s policy meeting. The recent economic news has shown a marked improvement, precluding the Bank from following on the previous two rate cuts this year. The key policy overnight rate is only 50 basis points (one-half of one percentage points) and another 25 basis point (bp) cut would only reduce the Bank’s ability to take action, if needed, in the future.

The slowdown in the Canadian economy in the first half of this year had nothing to do with interest rates and had everything to do with the massive decline in oil prices. As the Bank has noted, “financial conditions are accommodative and provide considerable support to economic activity”.

In addition, a 25 bp rate cut would only translate into a 12-to-15 bp cut in mortgage and other consumer and business borrowing rates, as we have seen with the January and July cuts. The reason is the cost of funds for the lenders has risen relative to risk-free government five-year bond yields–normally linked to mortgage rates–as investors risk appetites have declined. This rise in so-called credit spreads reduces the stimulative effect  of any rate cut by the Bank of Canada.

Moreover, the interest-sensitive sectors of the Canadian economy–housing, autos and other durable goods purchases–are already booming. Business investment has declined sharply, but only in the oil patch, which would not be reversed by lower interest rates. Another rate cut would only encourage increased household indebtedness and, at the margin, make little difference.

The good news is that the U.S. economy has rebounded sharply from the first quarter slowdown, with second quarter growth of 3.7 percent surprising on the high side. This has helped to boost Canadian exports, particularly for autos and aircraft. As the Bank expected, the weaker Canadian dollar has spurred the demand for Canadian products in the U.S. and elsewhere.

To be sure, the Chinese economy has slowed, putting downward pressure on certain commodity prices important to Canada’s exports, but the pick up in the U.S. has finally provided a meaningful offset.

The Bank of Canada is at last seeing the stimulative effects of its earlier rate cuts and is confident that the five-month decline  in economic activity has halted with the stronger-than-expected 0.5 percent growth in June. The increase in June was broad-based. Also, more recent data show a strong uptick in employment growth. Third quarter GDP growth is in train to meet or exceed the Bank’s forecast of 2.5 percent, a welcome reversal of the first-half slide.

While core inflation has been about 2 percent, the Bank judges that the underlying trend in inflation remains at about 1.5 to 1.7 percent.

To be sure, the heightened volatility in financial markets, the slowdown in emerging economies and the potential further decline in oil prices will keep the Bank ever watchful. If the rebound in economic activity peters out later this year, which I doubt, the Bank will act quickly to cut rates once again. The next policy announcement date isOctober 21, just two days after the Federal election.

The Bank of Canada will maintain its benchmark rate when it meets next week, according to one ScotiaBank economist.

“We expect the Bank of Canada to remain on hold on Wednesday with the overnight rate unchanged at 0.5%,” Derek Holt, vice president of Scotia Economics, writes in the bank’s latest economic forecast. “It will be a statement-only affair with no forecast updates or press conference.They will come next in October.”

And Holt argues the Bank of Canada will maintain the status quo for the foreseeable future.

“By the end of this year, the vast majority of forecasters — including us — think the overnight rate will remain unchanged at 0.5%,” Holt writes. “By the end of next year, the vast majority either think the policy rate will remain stuck at this level, or it will be hiked. Our house view is a policy hold throughout this year and next.”

Holt’s prediction aligns with those of several mortgage brokers, who also believe the central bank will maintain its rate. Regardless of the decision, brokers expect it to have little impact on business.

The prediction follows the dreary Canadian jobs data, released by Statistics Canada Friday that showed the unemployment rate increased 0.2 percentage points to 7.0% in August.

Prior to August, the unemployment rate had held steady at 6.8% for six consecutive months..

The question of whether Canada remains in a recession is still unanswered.

Regardless, Holt argues economic policy has been too conservative.

Holt says the Bank of Canada “overreacted” to the economic headwinds facing the country, and that the easing was excessive.

Statistics Canada is reporting that GDP fell in the second quarter, confirming fears that the economy was in recession for the first half of 2015.

StatsCan says the economy contracted at an annual pace of 0.5 per cent in the second quarter of the year.

That was a smaller decline than analyst estimates but Statistics Canada says the first quarter shrank more than originally reported, with a revised decline of 0.8 per cent rather than 0.6 per cent.

On the positive side, Canada’s gross domestic product grew by 0.5 per cent in June, after shrinking for five straight months. The growth was led by a 3.1 per cent boost in natural resources extraction.

The fresh data is likely to add fuel to the heated political debate over how best to respond to the weakened economy as parties battle for support ahead of the Oct. 19 election.

The Statistics Canada report is also expected to intensify the economic argument over the severity of the technical recession _ defined as two consecutive quarters of declining GDP.

The last time the economy contracted over two consecutive quarters was in 2009 during the Great Recession, when GDP pulled back by 8.7 per cent in the first quarter and 3.6 per cent in the second.