UPDATE 2-Bank of Canada still signals higher rates possible

Fri Jun 22, 2012 1:05am IST

* Hawkish stance contrasts with U.S. Fed

* Says economy can't depend on debt-fueled spending

* Says new mortgage rules reduce risk to economy

By Richard Woodbury

HALIFAX, Nova Scotia, June 21 (Reuters) - The Bank of Canada is still considering interest rate hikes, it signaled on Thursday, wh ile cautioning it was keeping a close eye on Europe and saw less risk from a heated domestic housing market after the government tightened mortgage rules.

The central bank's hawkish stance contrasts with most of its Western peers, including t he U.S. Federal Reserve, which delivered another round of stimulus to the struggling economy there on Wednesday.

Governor Mark Carney said that despite the debt crisis in Europe, Canada's economy continues to grow and absorb slack, with resilient household spending supported by very low interest rates.

And while he said in a speech that the country's relatively good performance by global standards was largely due to unsustainable debt-fueled consumer spending, he later applauded the government's move on Thursday to tighten access to government-insured mortgages.

"These measures reduce the number one risk, domestic risk to the Canadian economy," he told reporters in Halifax, Nova Scotia after giving a speech.

Several analysts said Ottawa's measures aimed at cooling the heated housing market and making it harder for Canadians to borrow too much at today's extremely low rates meant the central bank had more room to keep rates low for longer.

"The tightening of the mortgage rules will reduce the pressure on the Bank of Canada to hike rates," said Charles St-Arnaud of Nomura Global Economics.

But Carney played down the correlation . "No, is the short answer," he said when asked if the mortgage changes w ere equivalent to several quarter-point interest rate hikes.

"These are measures that are very well suited to specific vulnerabilities, specific risks in the Canadian economy which relate first and foremost to financial stability. And I'm not going to be pulled into a monetary policy discussion which is targeted at price stability," he said.

GROWTH OUTLOOK TWEAKED

The Bank of Canada was the first among the Group of Seven advanced economies to lift interest rates from a record low 0.25 percent to 1.0 percent in 2010 following the global financial crisis.

It has not budged since then, but in April began tentatively signaling that rate hikes may be approaching as long as the economy keeps growing an d eating through spare capacity.

Analysts in a Reuters poll released on May 30 forecast the bank would resume rate hikes in the first quarter of 2013, while markets, contrarily, are pricing in the chance of a rate cut by the end of this year.

Carney did acknowledge that the bank would likely revise down its 2012 economic growth forecast from 2.4 percent, based on weaker-than-expected first-quarter performance. It will release its new det ailed pro jections on July 18.

Canada is vulnerable to any worsening of the European debt crisis, though the Bank of Canada has plenty of tools in its kit to stimulate the economy. Carney reminded his audience of the bank's contingency plan for credit and quantitative easing, unveiled at the height of the crisis but never used.

"I would say that the evidence from the U.S., the evidence from the U.K., to some extent from Switzerland where they've done it in a slightly different way but the same concept, has been that these policies are effective," he said.

In any case, Carney was encouraged by what he heard from European leaders at a G20 summit in Mexico this week, particularly their support for a European banking union and closer fiscal integration over time.

"It's a mistake to underestimate the resolve of European leaders to address these issues," he said.