Mark Carney’s juggling act

Mark Carney is juggling a better economic outlook with a strong dollar, slow productivity gains and an uneasy global recovery.

These factors stopped the Bank of Canada Governor from raising interest rates Tuesday even as he cited a slightly improved forecast for economic growth this year and next. Europe’s debt and bank troubles also mean “significant” uncertainty for the world economy

Holding the central bank’s benchmark overnight rate at 1 per cent, Mr. Carney and his rate-setting panel also drew attention to Canada’s current account deficit, which has swelled to the widest in two decades. A deficit in the flow of trade and foreign investment can provide an early warning of a country taking on too much debt, while a surplus can show it doing little to stimulate domestic demand.

The central bank believes recent moves to shore up the U.S. economy will boost demand south of the border and, in turn, benefit Canada. But the wording of Tuesday’s decision suggests Mr. Carney is worried that the “cumulative effects’’ of the currency and Canadian companies’ tepid progress in improving their productivity mean the country isn’t yet positioned to get everything it can out of brighter prospects for the United States.

A full explanation of how Mr. Carney and his colleagues now see the Canadian and global recoveries playing out will come Wednesday morning, in their latest quarterly forecast.

“Net exports are projected to contribute more to growth going forward, supported by stronger U.S. activity and global demand for commodities,” the bank said. “However, the cumulative effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance are restraining this recovery in net exports and contributing to a widening of Canada’s current account deficit to a 20-year high.”

Part of the current account gap is due to Canadian companies taking advantage of the strong loonie to buy new machinery and equipment overseas, a dynamic that has fuelled a surge in imports in recent months.

However, the productivity gains those purchases will yield could take years to make a sizable difference. And in the meantime, the higher production costs that come from being less efficient, and the currency’s effect on sales abroad, are tempering net exports just as Mr. Carney is counting on them to make a bigger contribution to growth as the impact of government stimulus fades and debt-strapped consumers spend less.

“If the U.S. is stronger, we’ll sell more to the U.S. regardless of what our currency is,’’ Michael Gregory, a senior economist at BMO Nesbitt Burns, said in an interview. “The question is how much more do we sell, and that’s where the currency and productivity come into play.’’

That doesn’t mean Mr. Carney is considering some type of intervention to tame the currency, Mr. Gregory said. But, he added, it does suggest the central bank is seeking to temper expectations for a return to higher interest rates before about midyear, regardless of how much the bank boosts its forecast for the U.S. economy, since raising rates while the U.S. Federal Reserve is still on hold could push the loonie even higher.

“Even if the global economy picks up, we still have this double-whammy problem of a strong currency, and lack of productivity growth – and that matters more to us at this stage than the fact the U.S. is picking up,’’ he said.

The Canadian economy will grow 2.4 per cent this year and 2.8 per cent in 2012, the central bank said Tuesday in a teaser to the forecast it will release Wednesday, compared to its October forecast of 2.3 per cent growth for this year and 2.6 per cent in 2012.

Without saying just how much of a kick Mr. Carney believes the U.S. economy could get from the tax-cut package President Barack Obama and Republicans in Congress agreed to late last year, or the Fed’s controversial attempt to keep long-term interest rates low by buying $600-billion (U.S.) in bonds, the central bank said private demand in the United States has picked up and will be “reinforced” by both measures.

At the same time, the Bank of Canada said risks to the global recovery remain “elevated.’’ Also, significantly, the central bank did not alter its October projections for inflation to return to its 2 per cent target at the end of 2012, or for the “considerable slack” left over in the economy from the recession to be absorbed by the end of that year.

The lack of inflationary pressures, and measures introduced Monday by Finance Minister Jim Flaherty to clamp down on household debt, give the central bank more flexibility to keep rates where they are for longer. Most economists predicted Tuesday that Mr. Carney would do just that.

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