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Economy Bank of Canada still fears low inflation despite balanced outlook

Bank of Canada Governor Stephen Poloz takes part in a news conference in Ottawa on July 16, 2014. Mr. Poloz said on Monday the central bank remains more worried about too-low inflation even though it believes the upside and downside risks are balanced, sending another signal that interest-rate hikes are more likely to come later than sooner.

Blair Gable/Reuters

Bank of Canada Governor Stephen Poloz said the central bank remains more worried about too-low inflation even though it believes the upside and downside risks are balanced, sending another signal that interest-rate hikes are more likely to come later than sooner.

"If there were a realization of an upside risk, that actually would be good news, given where we are. However, if we realized a downside risk, that would be a more significant event," he told a news conference following a speech to the Canadian Council for Public-Private Partnerships annual conference in Toronto.

"So in that sense, the risks are imbalanced from a policy perspective, even though they look symmetric as a forecast. The downside risk would be a much harder challenge … Policy makers are understandably preoccupied with those concerns. And if they're wrong and things turn out to be stronger, that would be just fine," he said.

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Mr. Poloz also indicated that alternative measures of the slack in the labour market, most notably the central bank's recently developed Labour Market Indicator, have taken a more prominent role in the bank's assessment of how much excess capacity there is in the economy – a key to determining when rate increases become appropriate.

"We can't ignore the labour market measures at a time when we know that they're likely to tell us more [about slack in the economy]," he said.

The news conference followed a speech in which Mr. Poloz defended ultra-low interest rates as necessary to support an economy still facing numerous headwinds in the wake of the financial crisis and Great Recession. While critics worry that too-low rates for too long could over-inflate the economy and fuel debt and asset bubbles, Mr. Poloz insisted that "the consequences of an upside risk would be more manageable than those associated with a downside risk."

In the speech, he reiterated the bank's position that it will take "around two years" before Canada's output gap closes and its economy is back to operating at full capacity, and that if the headwinds persist, "continued policy stimulus may still be needed to offset them even after our excess capacity has been absorbed."

Mr. Poloz's comments build on a message the central bank has delivered in several speeches and publications over the past two months, after market speculation had percolated over the summer that the bank might be ready to raise rates sooner than expected, in light of rising inflation and a strengthening economy.

This was Mr. Poloz's first news conference since the release of the central bank's quarterly Monetary Policy Report on Oct. 22. Normally, the governor holds a news conference the day of the MPR release, but it was cancelled due to the fatal shootings that day on Parliament Hill, just steps from where the news conference was to have taken place.

After the MPR was released, the bank did publish the opening statement Mr. Poloz had prepared for the postMPR news conference, and the governor addressed the Senate banking committee last week. In both cases, he emphasized the deep economic wounds left by plant closings and business restructurings in recent years, which has permanently eliminated many jobs and left the labour market rebound lagging that of the rest of the economy.

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"In a typical recession, the output gap and the labour market gap look the same. But when there's structural damage to the economy, then they diverge. [In] a longer cycle, like the one we're living through, the exit of firms in the export sector are a symptom of that damage," he said in the news conference. "When that happens, the labour market gap becomes your ultimate measure of how much capacity there is in the economy."

Last year, the Bank of Canada developed a Labour Market Index, a composite of nine labour indicators, and the index has taken on a more prominent role in its assessment of economic slack this year. Mr. Poloz said he expects the bank to publish the index readings publicly on a more regular basis, including adding it to the key indicators it posts on its website.

"It's become a pretty good balancer of the various things we're looking at. So you'll see it on a regular basis."

Turning to key domestic risks to the Canadian economy, Mr. Poloz said the housing market doesn't look overbuilt relative to demographic growth. And he said that outside of high prices in Toronto, Vancouver and Calgary, "the rest of the country seems to be very well in line with all the fundamentals."

He said the central bank has been taking a closer look on potential excesses in the auto-lending market, and will report on that issue in its Financial System Review publication in December.

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