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OTTAWA (Reuters) - Canada cannot "cut and paste" monetary policy from elsewhere and, unlike its struggling peers, will need higher interest rates as the economy inches closer to its speed limit, Bank of Canada Governor Mark Carney said on Wednesday.
Carney is in a lonely position as the only central bank chief in the major advanced economies who is talking of raising rates while everyone else is moving in the opposite direction.
But he was quick to defend that stance in a news conference even though the quarterly report he was releasing downgraded growth forecasts for Canada, the United States and the global economy.
"We make monetary policy for conditions in Canada. Monetary policy is extremely accommodative, financial conditions are extremely accommodative," Carney told reporters.
"We're in a situation where there's a very small amount of excess capacity in this economy. Rates are at 1 percent. They're very low ... Global monetary policy is not a cut and paste."
Carney was the first in the Group of Seven industrialized nations to hike rates after the global financial crisis but has kept the bank's benchmark rate frozen at 1.0 percent since September 2010.
Now, with the economy running at just half a percent below its production capacity - the speed at which it can grow without fueling inflation - he is preparing to tighten the screws again.
"This projection includes a gradual reduction in monetary stimulus over the projection horizon, consistent with achieving the inflation target," the bank said in its Monetary Policy Report.
Most economists expect the first hike to come in the second quarter of next year, but traders in the overnight index swaps market are pricing in a small chance of a rate cut this year. <CA/POLL>
"The underlying bias to take interest rates higher confirms our view that the next move in the overnight rate is up and not down," said David Tulk, chief macro strategist at TD Securities.
Others were skeptical. Derek Holt of Scotia Capital suspects Carney of talking tough in an attempt to influence overly-dovish markets.
"I continue to think that the main point to the Bank of Canada repeating its upward rate guidance is to fight the market bias in favor of a rate cut more so than to actually signal that it will raise rates," Holt wrote in a note to clients.
The bank also predicted Canadian households will see their debt burden worsen further in coming months even after the government stepped in to tighten mortgage rules, pointing to signs of "overbuilding" in the housing market.
It said the measures the government announced in June to curb mortgage borrowing would help make the housing market more sustainable, but it still expressed concern.
"Despite the lower forecast for household spending ... the bank continues to expect further increases in the household debt-to-income ratio in coming quarters," it said in its quarterly Monetary Policy Report.
The debt-to-income ratio of Canadian households soared to an all-time high of 152 percent in the first quarter as ultra-low borrowing costs lured more people into buying homes and as home prices in some cities rose sharply.
The central bank, which has warned the trend is the top domestic risk to the economy, said the pace of growth in household credit had slowed this year and consumer spending would likely be weaker than it anticipated last quarter as global economic troubles bite into incomes and wealth.
But housing investment remains robust due to construction of multi-family buildings and home renovations, and this is taking a toll on household finances.
"While growth in household spending has been moderate in recent quarters, it has been disproportionately supported by housing investment, which is around historical highs and showing signs of overbuilding," the bank said.
A good deal of the mortgage growth is likely to be transitory, caused by strong activity in the housing market in early 2012 before the government tightened mortgage rules.
The bank sees economic growth troughing in the second quarter at an annualized 1.8 percent, down from its 2.5 percent projection in April. It sees growth of 2.0 percent and 2.3 percent in the third and fourth quarters, respectively.
The 2012 revisions largely reflect weaker-than-expected government spending, business investment and consumer spending while the outlook for net exports improved slightly.
The bank sees inflation sharply lower at 1.7 percent in the second quarter, 1.2 percent in the third and 1.6 percent in the fourth.
Editing by Jeffrey Hodgson