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Mark Carney, the head of the Bank of Canada, speaks at a press conference after addressing the annual convention of the Canadian Auto Workers Union in Toronto on August 22, 2012.

Peter Power/The Globe and Mail

The Bank of Canada is putting the present threat of a crumbling global economy ahead of a creeping worry that ultra-low interest rates are sowing the seeds of the next financial crisis.

Mark Carney, the central bank's governor, left the benchmark interest rate at 1 per cent Wednesday – now unchanged for two years – extending the longest period of static interest rates since the mid-1950s.

In a statement explaining the decision, the Bank of Canada indicated at least slight concern that external headwinds could knock the country's economy off course. Some economists saw a pivot, arguing the central bank could be forced to drop its stated intention to raise interest rates because doing so would hurt exporters by putting upward pressure on the dollar.

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For now, economic conditions are evolving "largely" as policy makers foresaw at the time of their last forecast in July, and the central bank indicated for the fourth time since April that it is inclined to increase borrowing costs as soon as possible.

The Bank of Canada noted Wednesday that Canada's household debt burden continues to rise. That trend likely won't change significantly until it becomes more expensive to borrow, which is why Mr. Carney is trying to condition Canadians to expect higher interest rates.

However, the Bank of Canada acknowledged that growth in China and other big emerging market economies is "decelerating somewhat more quickly" than anticipated. If that persists, Mr. Carney could be forced to alter course when he and his advisers draw up a new outlook in October. Tepid economic growth in the U.S. is offsetting a recession in much of Europe. That means near-term prospects for the global economy rest with the China and countries like it.

"The only thing that can bring us a recession is the emerging markets and the only thing that can bring us growth are emerging economies," Denis Senécal, head of fixed income and cash at State Street Global Advisors, said from Montreal.

As a result, outlooks for Canadian interest rates are tied to forecasters' predictions of where the global economy is headed.

Paul Ashworth, chief North America economist at Capital Economics in Toronto, said Canada's economic momentum has stalled and that the Bank of Canada could be forced to cut the benchmark rate next year as the global economy continues to deteriorate. Economists at Toronto-Dominion Bank see things differently. Jacques Marcil told the bank's clients in a note that the global economy should rebound by early next year and predicted the central bank will lift borrowing costs by the spring.

The Bay Street debate over Bank of Canada policy rarely considers a more theoretical question: whether it's a good idea to leave borrowing costs so low for so long.

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Last week, William White, the Canadian economist who correctly predicted that the U.S. housing boom was a harbinger of trouble, published a new paper that argues ultra-low interest rates risk a lengthy list of "unintended consequences," including stoking inflation, inflating new asset-price bubbles and exacerbating income disparity.

"None of these 'unintended consequences' could be remotely described as desirable," wrote Mr. White, a former Bank of Canada and Bank for International Settlements economist who currently advises the OECD. He said central banks should stand down and turn the job of saving the recovery over to governments.

Mr. White's opinion carries weight in policy circles.

The potential for low interest rates to create a housing bubble explains why the Bank of Canada has been preparing businesses, households and investors for higher rates. "To the extent that the economic expansion continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate," the central bank said in its statement, repeating to the letter language that was first introduced in April.

A slower global economy would delay that excess supply from being absorbed, giving the central bank cause to refrain from boosting interest rates. Even those who worry about the longer-term effects of ultra-low interest rates say the Bank of Canada likely would back down from its threat of higher rates if global demand evaporates further and commodity prices stumble.

"The Canadian economy is like a boat in the ocean," said Darcy Briggs at Franklin Templeton Investments in Calgary. "Our economic fortunes are dictated by what's going on in the rest of the world."

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