September 6, 2018 / 6:56 PM / 12 days ago

UPDATE 2-Bank of Canada hints it may hike rates even if NAFTA collapses

(Adds strategist quotes and details on market activity; adds byline)

By Michael Joel-Hansen

REGINA, Saskatchewan, Sept 6 (Reuters) - A senior Bank of Canada official on Thursday indicated the central bank may be forced to raise interest rates if talks to renegotiate the NAFTA trade pact fail, saying protectionist measures could spur inflation.

Senior Deputy Governor Carolyn Wilkins - speaking a day after the Canadian central bank held rates steady - reiterated that more rate rises would be warranted to keep inflation on target. The BoC’s goal is to keep inflation at 2 percent.

Talks to update the North American Free Trade Agreement (NAFTA), which groups the United States, Canada and Mexico, are continuing in Washington, and Wilkins said the bank might be faced with a complex monetary policy trade-off. On the one hand, a collapse of the pact would hit wages, income and growth as higher tariffs kicked in, she said.

“On the other hand, protectionist measures create risks to the upside for inflation, especially when the economy is operating near full capacity. In weighing these trade-offs, you can be sure that Governing Council will not lose sight of our primary mission,” she said in the prepared text of a speech.

“Low and stable inflation will help reduce at least one source of uncertainty for companies and households,” she added. The bank has raised rates four times since July 2017 as the economy has strengthened.

Wilkins said “the implications of the current trade environment” had dominated the bank’s discussions ahead of the Wednesday rate announcement.

She said although the Canadian economy was on a solid footing, trade issues were taking a toll. Businesses are wary of making investments, given the uncertainty over NAFTA.

A Reuters poll of economists last week had predicted the central bank was likely to leave rates unchanged. The bank’s next fixed date for unveiling a decision on rates is Oct. 24.

The bank’s governing council had discussed whether the gradual approach to raising rates was still appropriate and concluded that it is, Wilkins added.

“The fact that they talked about dropping the gradual hiking of rates, that was something that the market was not expecting,” said Hosen Marjaee, senior managing director, Canadian fixed income at Manulife Asset Management.

The Canadian dollar recovered from a nearly seven-week low after the comments to end the day about 0.4 percent higher, while yields on shorter-dated Canadian bonds rose. (Additional reporting by David Ljunggren and Fergal Smith, editing by G Crosse and Cynthia Osterman)

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