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Bank of Canada Governor Mark Carney is expected to leave rates unchanged at the Bank of Canada's February meeting. (Sean Kilpatrick/Sean Kilpatrick/The Canadian Press)
Bank of Canada Governor Mark Carney is expected to leave rates unchanged at the Bank of Canada's February meeting. (Sean Kilpatrick/Sean Kilpatrick/The Canadian Press)

Monetary policy

Mr. Carney's rate dilemma Add to ...

Fears that Libya could send oil soaring to new heights and spark another global downturn had eased by the end of last week, but the unpredictability of upheaval in the region gives Mark Carney yet another reason to keep rates on hold for longer than most expect.

On Tuesday, the Bank of Canada Governor is expected to leave his benchmark interest rate at 1 per cent, where it has been since last September. The real question is whether he'll drop any hints about when he intends to start tightening again.

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Most economists say a strengthening labour market, greater investment by businesses and a resurgent export sector will push the central bank off the sidelines in late May or mid-July, and possibly sooner if the next inflation report from Statistics Canada shows higher energy and food costs seeping into other areas.

But a small group of outliers has been saying for months that Mr. Carney might stay on hold until October or later, a timeline that would mark the second pause of more than a year since the crisis started in 2008. Increasingly, it looks as if they may be right.

True, the accelerating rebound in the U.S. economy - Canada's No. 1 customer - 'points to faster growth on this side of the border, too. A report from Statistics Canada on Monday will probably show that in the fourth quarter, the annual pace of expansion surpassed the 2.3-per-cent rate Mr. Carney estimated in January. Trade figures from December indicated tax cuts and other steps to boost the U.S. helped Canadian exporters clock their best month in three decades. And in January, employers hired four times as many workers as anticipated, a sign that momentum from late last year carried over into 2011.

However, the 7.8-per cent jobless rate is keeping a lid on wages, which is partly why inflation remains well within Mr. Carney's comfort zone. The central banker aims to keep annual inflation around 2 per cent and pays closest attention to a measure of price gains that strips out things like gasoline, electricity and most groceries. In January, that so-called annual core rate was 1.4 per cent, a tick slower than the previous month's pace.

Also, recall that at his last decision on Jan. 18, Mr. Carney held firm even while citing a slightly improved forecast for the economy this year and next. Europe's debt and bank troubles continued to be a "significant" source of uncertainty, he said at the time and could easily still say today. And though things were looking up for the United States, the "cumulative effects" of a currency at par with the greenback and Canadian companies' tepid progress in improving their productivity would restrain companies' ability to reap the rewards, he warned.

That was before revolutions in Tunisia and Egypt unleashed the torrent of protest across the region which last week sent oil prices past $100 (U.S.) a barrel for the first time since 2008, when $150-a-barrel crude exacerbated the burgeoning global financial crisis.

By the end of last week, the general consensus seemed to be that while past oil shocks have led to recessions, all will be fine this time around as long as suppliers bigger than Libya, such as Saudi Arabia and Iran, don't implode, too, and as long as prices don't surge beyond about $120 for a long stretch. Indeed, as a net exporter of oil, higher prices aren't necessarily bad for Canada, and of course are great for energy companies in Alberta.

Nonetheless, the potential stumbling blocks for the Canadian economy are many.

Higher oil prices will make it harder for China, India and other rapidly-growing emerging markets to contain inflation without aggressive tightening moves that choke off demand, while also squeezing the ability of consumers in the United States and Europe to spend money on anything other than basics like energy and food.

"The Bank of Canada is in a bind, because it's stuck in an environment where the strength in the domestic economy signals rates need to go up, but the external side shows there's still a lot of risks," Craig Alexander, chief economist at Toronto-Dominion Bank, said in an interview. "There's risks around sovereign debt in Europe, there's risks around excessive strength and inflation in emerging markets, there's risks around the U.S. recovery, and now there's risks around geopolitics in the Middle East." Worse, the loonie could climb higher, making it that much harder for manufacturers in central Canada to sell their goods abroad and making their operations more costly, at least for a while.

"As long as the instability doesn't continue, short-term price spikes are not so much of a concern for businesses, but what is a major concern right now is what the impact will be on customers," said Jay Myers, president and chief executive officer of Canadian Manufacturers & Exporters. "A lot of the recovery in central Canada has been auto-related, and a lot of the recovery in the auto sector has been driven by consumer purchases (in Canada and the U.S.) of larger vehicles and trucks, so that's an area that would probably be extremely sensitive to sustained high energy costs." TD's Mr. Alexander is in the camp that says the global economy will ride out the oil storm and domestic conditions in Canada will force Mr. Carney to start raising rates beginning with his July 19 decision. Still, Mr. Alexander acknowledged that persistent uncertainty around the world could delay the central bank.

At the very least, it could mean Mr. Carney pulls the trigger in July to gain some of the ground he needs to make up to get rates back to a "neutral" level - 3.5 per cent or 4 per cent - and then goes back to the sidelines in case more trouble flares up outside of Canada.

Indeed, Mr. Carney will be wary of pulling too much stimulus away too quickly while world events, and exporters' medium-term prospects, remain so unsettled.

"The one thing they don't want to do is have to reverse course," Mr. Alexander said.

So, even as Mr. Carney sprinkles his statement Tuesday with evidence that the domestic rebound is gathering steam, he will continue to stress the growing list of external wild cards.

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