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WATERLOO, Ontario (Reuters) - Canada's economy is doing better than expected and the threat from the European debt crisis has lessened, Bank of Canada Governor Mark Carney said on Monday, while warning that high household debt levels are unsustainable.
The speech largely echoed a more upbeat tone in the bank's March 8 statement and suggests the bank is inching toward an interest rate hike, although possibly not until next year.
"Conditions in the Canadian economy have...been somewhat stronger and the degree of slack somewhat smaller than the bank had expected," the central bank chief said in a speech to a business audience in Kitchener-Waterloo, Ontario.
He said the bank's monetary policy decisions would take into account the stronger growth profile, firmer-than-expected inflation, fiscal restraint recently announced by federal and provincial governments as well as households' dependence on debt financing, which he continues to see as the biggest domestic risk to the economy.
"The bank will take whatever action is appropriate to achieve the 2 percent CPI inflation target over the medium term," he said.
The bank's next interest rate decision will be announced on April 17. Market players expect the bank to maintain the overnight lending target at an extremely low 1 percent, and primary securities dealers surveyed by Reuters on March 23 expected the bank to hold rates steady until the third quarter of 2013.
The Bank of Canada became the first central bank in the Group of Seven advanced economies to raise borrowing costs after the global financial crisis. But it has held the rate at 1 percent since September 2010, awaiting signs that the U.S. economy is reviving and the European debt crisis is under control.
Carney now sees the European problems as "chronic" rather than "acute" and noted "encouraging" U.S. data, a view that could favor monetary tightening.
"Although still clearly not seeing the external side as a key driver of Canadian growth, the bank appears to be less concerned about the potential for events outside Canada to derail recovery than it was a month ago," said Peter Buchanan and Emanuella Enenajor, economists at CIBC World Markets.
"While any rate increase is still a long way off, Carney appears to be cautiously laying the grounds for a somewhat more upbeat economic forecast in the April 18 Monetary Policy Report," they wrote in a note to clients.
On the flip side, the strong Canadian dollar continues to drag on exports and growth, and spending cutbacks by the federal government and some provinces could give the bank some room to keep monetary policy stimulative for longer.
"The slightly more austere combined fiscal policy path would appear to be welcome given current conditions, and could slightly lessen any rate hike urgency," said Michael Gregory, senior economist at BMO Capital Markets.
Canada's central bankers will study not only the magnitude of the government spending cuts but also "the nature of the specific measures" taken in federal and provincial budgets to determine their economic impact, Carney said.
The Canadian dollar hit a session high after Carney spoke and the overnight index swap market, which trades based on expectations for the central bank's key policy rate, showed that traders increased bets on a rate hike in late 2012 after the speech was published.
Carney, in contrast to Finance Minister Jim Flaherty, gave no sign that his concern about the housing market and high household debt was abating. But he said monetary policy was a last resort for dealing with the problem, putting the onus on individuals, banks, regulators and the government.
He said Canadian household spending relies too much on low borrowing rates and the high value of homes, and that much of the money used to finance recent increases in household debt has come from abroad.
"These trends are unsustainable over the medium term," he said.
Carney's speech focused on the need to rethink the country's export strategy in light of chronically weak growth expectations for its main market, the United States, and the limitations of relying on domestic spending to fuel economic growth.
He said businesses should not rely on the Canadian dollar depreciating in value against the U.S. currency to make exports more competitive.
The strong currency is only one challenge for exporters though, he said, with the more important challenge being the reliance on slow-growing economies such as the United States and other advanced countries rather than fast-growing markets in Asia and other emerging economies.
Carney's push for new trade strategies is shared by the federal government, which is interested in selling oil to China. In its annual budget last week the government promised to deepen trade ties within the Asia Pacific region and others.
Additional reporting by Louise Egan and Randall Palmer in Ottawa; Claire Sibonney and Jon Cook in Toronto; Editing by Jeffrey Hodgson