UPDATE 1-Uncertainty, slack continue to weigh on Canada -Bank of Canada

Thu Oct 6, 2016 11:48am EDT
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TROIS-RIVIERES, Quebec, Oct. 6 (Reuters) - Inflation risks in Canada remain tilted to the downside as the economy takes time to adjust to the oil price shock and awaits a boost from fiscal stimulus and the U.S. economic recovery, a senior Bank of Canada official said on Thursday.

Pointing to material slack in the economy and continued uncertainty among businesses that has hampered investment, Senior Deputy Governor Carolyn Wilkins said there had been progress in the nation's economic adjustment, but also some setbacks.

"The Bank is providing monetary stimulus in order to meet its inflation target. The adjustments are clearly under way. But it will take time before the economy has fully adjusted to the oil price shock, the U.S. economy strengthens and the effects of fiscal stimulus take hold," she said in a speech to the University of Quebec in Trois-Rivieres.

Signaling the central bank was in no hurry to raise interest rates, Wilkins said global events, such as Britain's vote to exit the European Union, have undermined confidence and there continues to be more slack in the labor market than the overall unemployment rate would suggest.

She said that while an uptick in non-commodity exports in July and August was encouraging, uncertainty lingered due to questions about U.S. business investment growth. The effect of lower oil prices on the U.S. economy may have been less positive than anticipated, she said.

Wilkins said business investment is expected to subtract another percentage point from economic growth this year after subtracting 1.5 percentage points last year, with competition effects from exchange rates playing a role.

She noted that Mexico's currency has depreciated more than the Canadian dollar, but said recent weakening in Canada's currency is expected to support exports, "even though its influence on their growth rate has faded for the most part."

On the upside, Wilkins expects U.S. activity to recover over the next few quarters, as household spending and the labour market remain robust.

She said the effects of the Liberal government's fiscal stimulus in the way of tax cuts and infrastructure spending will become more prominent as the year progresses.

While the central bank continues to worry about financial vulnerabilities that come with Canada's record high level of household debt, Wilkins said the mortgage rule changes unveiled by the government on Monday will, over time, help mitigate risks to the financial system. (Additional reporting by Leah Schnurr and Andrea Hopkins; Editing by Bernadette Baum)