MNI POLICY: BOC to Set Policy Suited to Economy Near Capacity>

By Greg Quinn and Anahita Alinejad

     OTTAWA (MNI) - The Bank of Canada will set interest rates suited to 

a domestic economy running at about full capacity where the main risk is 

a "complex" shock from a deepening global trade fight, Deputy Governor 

Larry Schembri said in a speech Thursday. 

     Domestic inflation, economic growth and labor market conditions are 

all consistent with an economy "operating close to full potential," and 

policy makers "will continue to conduct monetary policy appropriate to 

our own circumstances," Schembri said. 

     The comments outlined the BOC's thinking behind its decision 

Wednesday to hold its key rate at 1.75%, surprising investors who 

exepcted signals for a cut as the U.S. and China escalate tariffs that 

could stall the global economy. Schembri's remarks are some of the 

clearest yet to indicate the BOC may stay on hold this year in contrast 

to fresh stimulus from the Fed, ECB and Bank of Japan. 

     "My colleagues and I began our discussions by recognizing that the 

data indicate the Canadian economy is operating close to full potential, 

the unemployment rate is near historic lows and inflation-our primary 

responsibility-is right on target," Schembri said. He also pointed out 

that the BOC's key rate is already half a percentage point below the 

Fed's benchmark, another nod to the idea Canada's economy has enough 

stimulus.

     "This solid starting point means the economy has a welcome degree 

of resilience to possible negative economic developments," Schembri 

said, pointing to inflation at 2%, second-quarter GDP growth at a 3.7% 

annualized pace and labor income growing at a 7% pace.

     "Our core inflation measures were also around 2 percent in July, 

which is consistent with the idea that the economy's output gap is 

essentially closed," he said. 

     Policy makers are paying close attention to trade as the major risk 

to the outlook, Schembri said, as well as signs that business investment 

and consumer spending have weakened. At the same time, the drop in 

global bond yields means households are refinancing the popular 

five-year mortgages at even lower rates this year, he said. That is 

boosting demand for a housing again after regulators stepped in to cool 

signs of speculative buying in Vancouver and Toronto. 

     The BOC's July foreast for a slowdown in the second half of the 

year that remains intact, Schembri said, without laying out a case that 

the so-called "output gap" would widen significantly over that time.

     While Canada's dollar rose yesterday as investors scaled back bets 

on a rate cut, some investors and economists maintain the BOC will act 

at the next decision on Oct. 30, citing a global slowdown fed by 

esclating tariffs. Schembri suggested the response to that scenario 

isn't clear cut for a central bank that has a single target of 2% 

inflation.  

     "Things could certainly get worse internationally, which would 

deliver a complex shock to our economy affecting both supply and 

demand," he said.

--MNI Ottawa Bureau, +1-613-314-9647, greg.quinn@marketnews.com

[TOPICS: M$C$$$,MACDS$]