January 18, 2012 / 4:08 PM / in 6 years

Bank of Canada sees households easing Europe pain

OTTAWA (Reuters) - The Bank of Canada said strong household spending will boost economic growth over the next two years, helping offset the impact of the European debt crisis, but warned that high household debt was a concern for policymakers.

<p>A cyclist passes the Bank of Canada building through a snow covered sidewalk in Ottawa January 17, 2012. REUTERS/Chris Wattie</p>

With economic slack expected to be eliminated by the third quarter of next year, the central bank governor, Mark Carney, made it clear in a press conference that he was not about to raise interest rates solely to slow the hot housing market.

In the bank’s quarterly Monetary Policy Report released earlier on Wednesday, the bank did say its economic projections assumed gradual interest rate increases through 2013.

“The projection includes a gradual reduction in monetary stimulus over the projection horizon, consistent with achieving the inflation target,” it said in its quarterly Monetary Policy Report.

The central bank, which on Tuesday left its benchmark rate target unchanged at 1 percent - below the current inflation rate - said corporate balance sheets were “in their best shape in living memory,” bringing good opportunities for investment.

That said, it repeated concerns about high levels of household debt, triggered in part by low borrowing costs.

“The biggest concern is taking extreme levels of debt for those who are most vulnerable and in an environment where the housing market has been quite robust for a period of time and is in some cases quite firmly valued, in other cased potentially overvalued,” Carney said at a news conference.

“There should be some caution in our view on bringing on additional debt.”

In its report, the central bank said the European debt crisis should shave 0.6 percent off Canada’s economy this year.

But strength in housing demand and consumer spending will likely sustain an economic expansion over the next two years.

The bank has held its target for the overnight rate steady at 1 percent since September 2010. Most economists expect the next move to be up, but not until 2013. <CA/POLL> Markets, on the other hand, are pricing in a rate cut.

The bank said it assumes Europe will be able to contain its debt crisis. Even so, it expects the impact on global financial conditions to become more widespread over the next two years, increasing funding pressures on banks, lowering confidence and making credit less available.

It forecast that the European crisis would dampen global growth considerably, and highlighted a potential failure to contain the European troubles as the most serious risk facing the global and Canadian economies.

The bank sees household and business spending as the main drivers of growth in Canada. It highlighted the buoyant housing market in the latter half of 2011 and record-low mortgage rates that should keep household borrowing high this year.

While that activity provides a welcome boost to the economy, the bank has also flagged high household debt as a looming danger to the economy, and its revised outlook effectively acknowledges that the risk has partially materialized.

With net exports restrained, it saw the current account deficit remaining significant, at about 3 percent of gross domestic product.

As widely expected, it sharply raised its forecast of fourth-quarter 2011 economic growth to an annualized 2.0 percent, from 0.8 percent.

At the same time, it trimmed quarterly forecasts throughout 2012. It sees growth of 1.8 percent in the first two quarters, with the rate accelerating to 2.6 percent by the fourth quarter, and then to 3.1 percent in early 2013.

“Confidence effects stemming from the weaker and more uncertain global outlook are projected to exert only a modest dampening effect on Canadian household spending,” it said.

Writing by Janet Guttsman; Editing by Jeffrey Hodgson and Frank McGurty

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