By Francois Biber
SASKATOON, Saskatchewan (Reuters) – The Bank of Canada will pay close attention to how the economy responds to both higher interest rates and a stronger Canadian dollar, and will be watching rising protectionist sentiment for the risk it poses to growth, a top official said on Monday.
Bank of Canada Deputy Governor Timothy Lane said growth is becoming more broadly based and self-sustaining, while expanding imports of machinery and equipment and other intermediary goods are early signs of rising business investment.
“We will be paying close attention to how the economy responds to both higher interest rates and the stronger Canadian dollar,” Lane said in prepared remarks in Saskatoon.
“We are seeing widespread strength in business investment and exports, in conjunction with a global economic expansion that is becoming more synchronous,” he said.
Lane warned that if trading rules are changed in a way that undermines the greater efficiencies and heightened competition that come with free trade, Canada could lose demand for exports, resulting in lower potential growth and implications for monetary policy.
“For example, lower potential would mean that the expansion of the economy generates inflationary pressures sooner, and so policy would have to respond to that,” Lane said.
But given the complexity of the changes and the fact new trade policy would likely affect both actual and potential economic growth, the bank “cannot adjust monetary policy in anticipation of these risks,” Lane said.
He said the bank would be watching the trade negotiations very closely to gauge their implications for exports and business investment, noting the possibility of a “material protectionist shift”, particularly linked to NAFTA, is a key source of uncertainty for Canada’s economic outlook.
The bank has made progress in understanding why it has taken so long for Canada’s exports to recover in the wake of the great recession, Lane said.
“Global economic forces – the sharp movement of commodity prices; the Great Recession and the lackluster global economy in its aftermath; and, for much of the past decade, a strong Canadian dollar – battered many of our export industries and splintered their supply chains,” he said.
But he reiterated the bank’s previous assertion that economic data is showing more broad-based and self-sustaining growth in Canada, along with strength in exports.
“Imports are also expanding; the increases we are seeing in imports of machinery and equipment and of various intermediate products are early signs of rising business investment,” Lane said.