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Bank of Canada Governor Mark Carney

Ryan Remiorz/THE CANADIAN PRESS

The stakes are high for Canada as the U.S. hurtles toward the so-called "fiscal cliff" deadline, Bank of Canada Governor Mark Carney says, including the threat of an economic stall in this country.

Canada would be dragged close to another recession if U.S. President Barack Obama and Congress can't strike a deal to avoid steep tax hikes and spending cuts set for Jan. 1, Mr. Carney warned Tuesday in an interview with The Globe and Mail.

And yet if the two sides strike a deal, the Canadian economy could be in for a New Year's bounce as consumers and businesses make up for lost time and resume spending, he said. "It's our view that if the Americans go over the cliff, that that economy will be in recession with material knock-on effects for Canada," Mr. Carney said, speaking before a speech to financial analysts in Toronto.

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The "fiscal cliff" is the most "acute risk" facing Canada, he said. The problem is "eminently solvable," but a deal could go down to the wire, he added. A successful resolution would be good for the Canadian economy, which has stalled alongside the U.S. in recent months, he said.

"The underlying U.S. economy is more firmly grounded and making more progress. So that if this could be resolved, truly resolved with a medium-term plan, that would be quite positive for the Canadian economy," he said, adding that in the United States "the financial system is in better shape, the household system has made a lot of progress, the housing market is turning."

He pointed out that U.S. corporations are "holding back" as the debate drags on. "So you take that away and you have a series of positives," he said.

On Tuesday, the U.S. fiscal debate continued to drag on, with talks deadlocked even as Mr. Obama and the House Republicans both floated new proposals.

The Bank of Canada's base-case scenario is that the U.S. economy will take a 1.5-percentage-point hit to gross domestic product in 2013 and 2014 from tax hikes and spending cuts, according to the bank's semi-annual review of financial risks released last week.

In a conference room with windows overlooking sprouting condominium towers, Mr. Carney told The Globe that he sees some positive signs that the measures taken to slow the growth of household debt and Canada's booming housing market are having an effect.

Stressing that he didn't want to "overplay" the situation, he pointed to "somewhat encouraging signs in terms of the slowing of the pace of the growth of household debt, adjustment of housing starts more towards the level of demographic demand" and "some adjustment in the resale market."

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In his speech, Mr. Carney pointed out that borrowers are starting to respond to the bank's signal that higher rates are likely coming. Canadians are adding to their record debt levels at a slower pace and they're moving out of variable-rate mortgages and into less risky fixed-rate loans.

"We have seen the pace of household debt accumulation slow, as hoped for, as intended," Mr. Carney told reporters after his speech. "We'll see if that persists."

The share of new fixed-rate mortgages has almost doubled to 90 per cent this year as homeowners move out of variable-rate loans to lock in today's relatively low rates before they go up, he said.

Last week, the bank warned that Canadians are still borrowing at a faster pace than their disposable income, making them more vulnerable if they lose their jobs or home prices tumble. The ratio of household debt to gross domestic product now stands at a record high 163 per cent, up from 161.5 per cent in June.

In his speech, Mr. Carney said the Bank of Canada's interest rate guidance is never an iron-clad "promise" and it will only signal the exact timing of monetary decisions in rare and exceptional circumstances. In "normal" times, he said the central bank must always adapt to changing economic conditions. The bank's current "guidance" is for "some modest withdrawal" of its current low target rate, which has been stuck at 1 per cent since September, 2010, to help the economy recover from the recession.

With files from reporter Tavia Grant and Bloomberg News

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