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OTTAWA (Reuters) - Financial markets ignored the enormous slack in the Canadian economy when they started betting that the Bank of Canada might raise rates earlier than mid-2010, Governor Mark Carney said on Thursday.
Ahead of the bank's rate decision on Tuesday, markets had started to price in the possibility that the bank would not reiterate its conditional pledge to keep the overnight interest rate at 0.25 percent through next June.
"In the run-up to that decision, there was some speculation in the markets that maybe we wouldn't do that. Markets have lost their focus," Carney told CPAC television, adding that holding rates at historic lows was currently the right policy to reach the bank's 2 percent inflation target.
On Tuesday the bank said the recent strength in the Canadian dollar had more than fully offset positive economic developments since July.
Its projections now assume the currency will be worth 96 U.S. cents (or C$1.0417 per U.S. dollar), roughly its current value.
Asked what would happen if it rises further, Carney replied: "It depends why it moves. It depends what else happens. And so we have considerable flexibility in terms of our policy options, regardless of what the currency does or whatever factors move."
The markets have been uncertain whether the bank would directly intervene in foreign exchange markets or engage in policies like quantitative easing (effectively printing money to buy assets), but Carney noted: "Nobody should be under any illusions that we don't have considerable options."
Praising the rapid fiscal stimulus that Canada's federal and provincial governments have injected into the economy, he said such measures would play a very important role in 2010 in what would still be a difficult period as the government seeks to "hand off" growth to the private sector.
"We don't see, for example, corporate investment really picking up until 2011 because of all that slack," he said. "2010 is still going to be a year where policy really matters."
Reporting by Randall Palmer; editing by Rob Wilson and Jeffrey Hodgson