Fears of another global downturn have eased enough for the Bank of Canada to at least start thinking about raising interest rates after 18 months on hold.
But Governor Mark Carney will proceed cautiously amid questions of whether recent signs of improvement can last and what the impact of higher borrowing costs would be on consumers who have gorged on ultra-cheap credit, economists say.
Mr. Carney illustrated this on Thursday as he held his key rate at 1 per cent while voicing concern over record household debt levels, which the central bank warned is the biggest domestic risk. The central bank has flagged the debt threat before, mainly because of what would happen to consumer demand if households curbed their spending.
The chances of Mr. Carney cutting rates have all but disappeared, and many forecasters believe his first increase since September, 2010, could arrive sooner than they expect. Yet most still say he will hold his fire until next year, and then move only once per quarter as he assesses whether the increases have been too much for the economy to handle, and whether a growing gap with the U.S. Federal Reserve is pushing the currency too high.
"The worst-case global financial contagion scenario is not playing out, so that risk to Canada is not increasing and clearly has diminished," said Sal Guatieri, vice-president of economic research at BMO Nesbitt Burns. "Now, does it warrant raising interest rates in the near term? Probably not, since the economy is still growing at a modest rate, and the dollar is around parity."
In a statement on its decision, the central bank said the slack in the economy – which grew at a 1.8-per-cent annual pace in the fourth quarter – is vanishing more quickly than it was anticipating, calling the outlook "marginally improved" since its January forecast, and saying inflation will be "somewhat firmer" than thought. Meanwhile, the world is on more solid footing, in part due to a healing labour market in the United States and "signs of stabilization" in Europe.
At the same time, much of the domestic strength is coming "as households add to their debt burden," policy makers said, a reminder of how uncomfortable Mr. Carney has become with this and how carefully he will have to tread when he does start stripping that stimulus away.
Mark Chandler, head of Canadian fixed income and currency strategy at RBC Dominion Securities, predicted that Mr. Carney, whose mandate is to keep inflation stable, may use his next forecast paper in mid-April and a semi-annual review of the financial system in June to spell out how the debt issue will influence his rate path.
"I think they're warming to the notion that it will be one of the factors causing them to move rates earlier, but the full explanation is yet to come," Mr. Chandler said. Referring to the bank's preference for relying on moral suasion and moves by regulators to make it tougher to get a mortgage, and the limited impact those avenues have had, he added: "They're running out of the tools they can use, besides raising rates."
Mr. Chandler is among the many Bay Street analysts who argue that the longer super-low borrowing costs continue to entice Canadians to pile on debt, the worse the hangover will be for the economy as a whole if too many people hit their wall at the same time.
Still, aside from the obvious need to slowly wean borrowers off of the easy-money conditions, there are other tripwires that argue for caution.
An out-of-control financial crisis in Europe that tips the world into another downturn seems less likely than a few weeks ago. But de-leveraging will restrain growth in the most advanced economies for years, the strong currency will hold back exports, and another run in oil prices could throw the global recovery off course, the bank said.
Moreover, belt-tightening in struggling provinces such as Ontario and Quebec will bite those economies this year, and once the U.S. presidential election is over, Canada's top export market is in for some brutal restraint in 2013. Some economists warn that depending on how that is carried out, it could chop as much as two percentage points off of growth in the U.S.
"Even if it's half of that, it's going to be a painful shock," said Bricklin Dwyer, a New York-based North America specialist with BNP Paribas, the French banking giant. "Staring at the edge of that, from Carney's point of view, is quite scary."