October 4, 2012 / 1:02 PM / in 5 years

Bank of Canada still eyes rate hike, sees jobs slack

The Bank of Canada's Senior Deputy Governor Tiff Macklem talks to Reuters in Montreal, October 5, 2010. REUTERS/Shaun Best

WINNIPEG, Manitoba (Reuters) - The Bank of Canada is still looking at the possibility of raising interest rates, but also believes there is some slack in the labor market that has not been taken up by the recovering economy, a top official said on Thursday.

In a speech to a business audience in Winnipeg, Manitoba, Tiff Macklem, senior deputy governor of the Bank of Canada, kept up the hawkish tone on rates the bank first adopted in April.

“To the extent that the economic expansion continues and the excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 percent inflation target over the medium term,” he said, using language almost identical to the bank’s September 5 rate announcement.

The Bank of Canada has held its key overnight rate target at 1 percent since mid-2010, but this year it resumed signaling its intention to tighten policy, in contrast to the stance of U.S. and European central banks. The Canadian economy has recovered more quickly from the 2008-09 recession than its Western peers.

The Canadian dollar rose to C$0.9834 to the U.S. dollar, or $1.0169 after Macklem’s comments. It closed at C$0.9881 to the U.S. dollar, or $1.0120, on Wednesday.

Most of Canada’s primary dealers expect the bank to hold rates steady until the second half of 2013 because of pressures from the troubled European and U.S. economies and slowing Chinese growth. No change is expected at the bank’s next rate announcement date on October 23.

Traders are more skeptical. Yields on overnight index swaps, which trade based on expectations for the central bank’s main policy rate, are pricing in only a modest chance of a hike late next year.

JOB MARKET SLACK REMAINS

While the country’s job market has recovered more quickly from the recession than those in other countries, it still has a way to go, Macklem said. The central bank closely monitors labor conditions to assess how fast the economy is growing and when a rate hike might be warranted.

“With a relatively quick recovery in employment, much of the slack in the labor market following the 2009 recession has been taken up. Nevertheless, most indicators suggest that some slack remains,” Macklem said.

The comments indicated the bank believes the overall economy has not yet reached its full capacity, suggesting it may be in no rush to tighten monetary policy.

“Gauging the tightness of the labor market is a key element in assessing how close the economy is operating relative to its capacity, which, in turn, is an important indicator of inflationary pressures,” Macklem said.

Growth has to exceed an annualized 2.0 percent for excess capacity to be absorbed, according to calculations by the Bank of Canada, which has forecast third-quarter growth will rise to 2.0 percent from a revised 1.9 percent in the second.

Growth expectations are fairly tepid after downward revisions to June gross domestic product growth figures neutralized an unexpected 0.2 percent monthly gain in July. Annual inflation in August was well below the bank’s 2 percent target.

Macklem rejected claims that the jobs gained since the recession have been of poor quality, saying more than 90 percent of them were in industries that pay average or above-average wages.

The vast majority have been full-time jobs and in the private sector, he said.

However, the unemployment rate and the duration of unemployment remains above the average of the decade before the crisis and wage growth has been modest.

“The behavior of wages is not pointing to generalized excess demand for labor,” he said.

Macklem also reinforced comments that have been made by Bank of Canada Governor Mark Carney chastising corporate Canada for sitting on piles of cash instead of investing more.

Macklem said sluggish business investment in machinery and equipment has made Canadian workers less productive than their U.S. counterparts.

“This points to the fact that we need a sustained investment boom in this country,” he said in response to a question from the audience after the speech.

“We have a lot of ground to catch up. It’s been solid, it hasn’t been spectacular. It needs to be better than solid and it needs to be sustained.”

Writing by Louise Egan; Editing by Jeffrey Hodgson; and Peter Galloway

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