January 10, 2011 / 6:52 PM / in 7 years

Bank of Canada sees low rates during ho-hum recovery

KINGSTON, Ontario (Reuters) - Low inflation and weak growth mean Canadian interest rates must remain low for now, while households must be wary of taking on too much debt, a senior Bank of Canada official said on Tuesday.

In comments after her first speech since becoming one of the central bank's deputy governors in July last year, Agathe Cote said Canadian inflation remained lower than the bank might have expected for this stage in the economic recovery.

"I think the view is that there is still a significant amount of excess supply in the economy so monetary policy needs to be, in a sense, still accommodative in these circumstances," she said in response to a question from the audience.

The Canadian economy rebounded sharply from a shallow recession in 2009. But growth began to slow in the latter half of 2010, reflecting both a still fragile U.S. economy and three Canadian interest rate hikes between June and September.

The Bank of Canada has left rates steady since then, pending more evidence that the recovery is on solid footing.

"We have seen some encouraging signs in the last year in terms of inflation picking up, but it is still very low for this stage of the recovery compared to what we had in previous cycles," Cote said.

Cote, a member of the Bank of Canada's six-person rate-setting council, said a sudden weakening in the Canadian housing market could have a "sizable spillover" effect on other parts of the economy.

Her comments were was the latest in a series of warnings about risks posed by high levels of household debt.

"If there were a sudden weakening in the Canadian housing sector, it could have sizable spillover effects on other areas of the economy, such as consumption, given the high debt loads of some Canadian households," Cote said in her speech.

The bank fears that near record-low interest rates -- designed to help cushion the worst of the recession -- are persuading Canadians to take on too much debt. It says this could have harmful consequences once rates rise.

But Cote said debt levels are just one factor the bank takes into account when setting policy, and it is primarily focused on achieving its 2 percent inflation target.

The bank next sets rates on January 18 and markets see no change in rates at that time. However, a Reuters poll last week revealed most of Canada's primary securities dealers expect the Bank of Canada to resume raising interest rates sometime in the first half of this year.

Separately on Monday, Statistics Canada data showed the value of Canadian building permits unexpectedly tumbled 11.2 percent in November from October - a sign the once-hot housing sector continues to soften.

Cote said steps to curb household debt are starting to have an impact, but credit continued to grow faster than income.

"Without a significant change in behavior, the proportion of households that would be susceptible to serious financial stress from negative income or wealth shocks will continue to grow," she said.

Canadian government officials say they are cautiously optimistic the economic recovery will continue, while sounding alarms about the challenge posed by the weak U.S. economy, the European debt crisis and a strong Canadian dollar.

A central bank survey showed that companies were optimistic about the next 12 months, but many expect only modest growth, in part due to strong competition and moderate demand.

The bank's fourth-quarter business outlook survey said 49 percent of companies expected to boost employment in the next 12 months, up from 39 percent in the third quarter survey.

Writing by Louise Egan, David Ljunggren and Leah Schnurr

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