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Carney Says Canada May Need Higher Interest Rates

Bank of Canada Governor Mark Carney reiterated that higher borrowing costs “may become appropriate” if the country’s domestic-demand driven expansion continues, even amid signs of slowing growth this quarter.

Economic growth is expected to accelerate through next year and its momentum remains in line with potential output, Carney said in a speech today at a Canadian Auto Workers union convention in Toronto. The expansion this quarter may be curbed by “short-term special factors” such as maintenance shutdowns of energy projects, Carney said.

“To the extent that the economic expansion in Canada 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,” Carney, 47, said in the speech.

The Bank of Canada has kept its benchmark interest rate unchanged at 1 percent since September 2010, the longest pause since the 1950s. Carney said his monetary policy must balance encouraging a recovery hampered by slack in labor markets with the risks posed by having the lowest policy interest rate of any major economy not directly affected by the global crisis.

“Carney stuck to his guns despite the softening Canadian economy,” said Krishen Rangasamy, senior economist at National Bank Financial in Montreal. “The tightening bias remains.”

Retail Sales

Earlier today, Statistics Canada reported that retail sales unexpectedly fell 0.4 percent in June, a result weaker than any forecast in a Bloomberg News survey of 24 economists, which had a median projection for a 0.1 percent gain. Other reports this month have shown declines in employment, wholesale sales and building permits along with slowing consumer-price increases.

Asked why he’s keeping the inclination to raise rates after recent signs of economic weakness, Carney cited the “relatively modest” amount of spare capacity in the economy, adding that “rates are lower here than they are in any other non-crisis economy.”

Canada’s dollar weakened 0.4 percent to 99.28 cents per U.S. dollar at 1:51 p.m. in Toronto. It touched 98.47 cents yesterday, the strongest level since May 3. One Canadian dollar buys $1.0073. Bonds rose, with the yield on the benchmark two-year government bond falling 5 basis points to 1.13 percent.

While cheap borrowing costs have supported growth in domestic demand, they have also fueled household debt and housing purchases that have led to “increasing signs of overbuilding and overvaluation” in some segments, Carney said in his speech.

Growth Limits

“As effective as it has been, the limits of this growth model are becoming clear,” Carney said in the speech. “We cannot grow indefinitely by relying on Canadian households increasing their borrowing relative to income.”

Carney said the Bank of Canada will back moves by the government and regulators to reduce risks in the housing market if needed.

“Under flexible inflation targeting, the Bank of Canada is prepared to support regulatory efforts, if necessary,” he said.

Carney said that while exports are poised to improve, they will remain below pre-recession levels until the start of 2014.

To improve exports, Canada needs to sell more to faster-growing emerging markets and further improve worker skills, he said. The country’s reliance on shipping to advanced economies such as the U.S. explains two-thirds of its falling share of global exports over the past decade, he said, while the strength of the Canadian dollar explains about 20 percent.

U.S. Over-reliance

“Our underperformance prior to the crisis was more a reflection of who we traded with than how effectively we did it,” he said. Canada may have been “over-reliant on the United States” in the past, he said.

Carney was asked several times today by the audience and in the press conference about the role of the currency in restraining exports.

“The dollar is not the sole answer to our challenges” on trade, Carney said in response to one question.

Carney also said that some companies that are holding excess cash instead of investing to become more competitive should consider returning the money to shareholders.

“The level of caution could be viewed as excessive,” Carney said. “Their job is to put money to work, and if they can’t think of what to do with it they should give it back to their shareholders.”

Carney, who also chairs the Financial Stability Board group that’s writing new rules for global finance, also called for the quick and full implementation of capital rules and cited the resilience of Canada’s financial system as an example of the benefits of stronger regulation.

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