Bank of Canada Governor Mark Carney pauses during a news conference in this file photo.CHRIS WATTIE/Reuters
Bank of Canada Governor Mark Carney is pledging a cautious approach to raising interest rates.
The central banker said in a forecast Wednesday that the recovery is picking up steam, and a key measure of inflation will reach his 2-per-cent target much sooner than expected. But he quashed expectations for an aggressive tightening campaign, saying global risks like Europe's debt crisis have intensified, and the strong dollar is holding back exporters' sales prospects.
Mr. Carney had signalled on Tuesday that Canadians should get ready for higher borrowing costs, possibly before the end of the year. On Wednesday, he made it clear that any increase will be gradual, which will come as a relief for the many households that used super-low borrowing costs to pile up debt that will be harder to carry as rates rise.
In his forecast, which is published four times a year, and later in a news conference, Mr. Carney outlined a forceful case for why he has been on hold for 10 months with a benchmark rate of 1 per cent that he calls "exceptionally stimulative" for a relatively strong economy.
Essentially, his argument boils down to a rejection of "mechanical" standards favoured by many economists, particularly in the academic community, who argue that inflation could get out of hand unless borrowing costs are brought to a more "neutral" level - historically, closer to 3 or 4 per cent - by the time the slack in the economy has been absorbed.
According to the central bank, unless the debt crises on either side of the Atlantic deteriorate or something else throws its "base case" projections out of whack, that will happen in the middle of next year. For Mr. Carney, though, long-term "substantial headwinds" like the strong loonie and a U.S. economy that is a shadow of its former self, mean borrowing costs may need to be lower for longer, and can be so without triggering uncontrollable price rises.
"We are going to calibrate monetary policy very carefully … to achieve our inflation target in a timely manner, but in an appropriate manner, in a sustainable manner," he said. "If we were on autopilot right now according to some mechanical rule, we would be ignoring the very real headwinds to this economy from the dollar, from the U.S., from Europe, and other risks that could present themselves, both positively and negatively."
While he would not say precisely where interest rates are going, economists interpreted his comments as implying that the benchmark rate could still be as low as 2 per cent in mid-2012.
"They're going to take it one step at a time," Douglas Porter, deputy chief economist at BMO Nesbitt Burns, said in an interview. "To me, it doesn't take away from the fact he's likely to hike rates when the opportunity presents, but those rate hikes are likely to be modest."
Mr. Porter sees the central bank raising rates in October and December, assuming nothing else flares up overseas, reaching mid-2012 with a policy rate of 1.75 per cent. Some economists say Mr. Carney will move at his next decision, on Sept. 7, although that seems less likely, since the question marks that kept him on hold this week are unlikely to have been resolved.
"They'll need to be convinced that the U.S. soft patch was just a patch and not an acreage," Mr. Porter said. "They'll need some real signs that the U.S. and the Canadian economies have indeed started to perk up again, and September is probably too early for convincing evidence of that."
According to the quarterly forecast, the domestic recovery is picking up steam after a dismal second quarter, and will grow more quickly than policy makers initially expected through the first three months of next year.
The bank's preferred gauge of inflation, which strips out volatile prices such as gasoline and certain fresh foods, will hit 2 per cent before the end of this year, more than six months sooner than in policy makers' April forecast, remaining around that level through the end of 2013.
Still, the bank's projections for Canadian growth depend in large part on the intensifying global risks failing to become reality. For example, policy makers said their forecast assumes European authorities will be able to contain that continent's debt crisis.