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Blog by Kevin Wong

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Bank of Canada Still Signalling Higher Rates Down the Road

The Bank of Canada is on cruise control.

Policy makers changed little at their last meeting under Governor Mark Carney, as they opted to leave the benchmark interest rate at 1 per cent for the 32nd consecutive month.

The central bank also repeated that its next interest-rate move – whenever that may be – most likely will be to take borrowing costs higher, a nod to concerns that ultra-low interest rates threaten financial stability by creating the conditions for runaway inflation and asset-price bubbles.

Canada’s economy is growing faster than policy makers had expected, the central bank acknowledged in a statement Wednesday.

That’s a switch, as the Bank of Canada’s tendency lately has been to overestimate the economy’s strength. According to Goldman Sachs, Canada’s gross domestic product likely grew at an annual rate of 2.5 per cent in the first quarter, compared with the central bank’s April estimate of 1.5 per cent.

Even with faster economic growth, policy makers believe Canada’s economy has considerable room to run. For months, output has been well below what the economy is capable of producing without triggering inflation.

As a result of that weakness, there is little reason to worry about inflation over the short term. The consumer price index is “slightly weaker” than forecast, the Bank of Canada said, giving officials reason to leave the benchmark interest rate unchanged. The central bank’s mandate is to keep prices advancing at a pace of about 2 per cent a year.

“With continued slack in the Canadian economy, the muted outlook for inflation, and the constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in the place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required,” the Bank of Canada said.

That statement has been the central bank’s mantra since the start of the year, when policy makers watered down their inclination to raise interest rates, noting that the growth of household debt was slowing to a pace in line with wage growth.

The trend has continued. Bank of Canada data published this week show household credit posted its slowest annual growth in 17 years in April. “The bank continues to expect that the household debt-to-income ratio will stabilize near current levels,” policy makers reiterated Wednesday.

An easing of Canadians’ debt burden is good for financial stability, as it reduces the risks of a wave of foreclosures and bankruptcies. But it comes as a cost to economic growth.

The debt build of recent years fuelled domestic spending that offset weak exports and lacklustre business investment. The central bank is counting on investment on international demand to take over from households. However, the central bank’s ability to influence either is limited.

Over the next couple of years, “consumer spending is expected to grow at a moderate pace, business investment to grow solidly, and residential investment to decline for historically high levels,” the Bank of Canada said. “Exports are expected to recover, but to be restrained by subdued foreign demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar.”

The central bank noted that Japan’s economy is “beginning to respond to significant policy stimulus.” However, Europe remains in recession; the U.S. recovery is being “partially offset” by government budget restraint; and China’s economic growth is easing, “weighing somewhat” on commodity prices, the Bank of Canada said.

Those factors suggest only “modest” global economic growth in 2013, the central bank said.