OTTAWA - The Bank of Canada is keeping interest rates at historic lows -- likely for another year -- even as it concedes that bargain-basement borrowing costs will lure households even deeper into debt.
As expected, the central bank kept its trendsetting policy rate at one per cent Tuesday, even thought the effect will be something it has repeatedly warned about -- higher levels of consumer spending, the piling on of debt and elevated house prices.
But in a gloomy new assessment of economic conditions, the bank implies it has no choice.
In a statement accompanying the announcement, the bank warned that global economy has, if anything, "deteriorated" since its last forecast in October and that risks arising from the European debt crisis have intensified.
For Canada, the global weakness will restrain exports and business investment.
"While the (Canadian) economy had more momentum than anticipated in the second half of 2011, the pace of growth going forward is expected to be more modest than previously envisioned," the bank's policy council, headed by governor Mark Carney, reported.
Economists said the tone of the report likely means the bank won't move to raise interest rates until 2013, and the CIBC said it doesn't expect rates to rise until as late as 2014.
"The Bank of Canada is caught between a rock and hard place," said Derek Holt, Scotiabank's vice-president of economics.
"They cannot tailor monetary policy to address a specific problem, which is elevated house prices, and at the same time (Carney) has to weigh that against the bigger macro picture, which is the total global risks. I think he's doing the right thing by straying toward global risks."
The Canadian dollar rose 0.36 of a cent to 98.59 cents US after the announcement as investors assessed the odds of a rate hike in the near future had diminished, while the odds of a rate cut might have increased.
Capital Economics economist David Madani said there was nothing in the statement that would make him alter his view the bank will halve its policy rate to 0.5 per cent sometime this spring.
Carney has warned for several years that he is concerned about Canadians taking on too much debt, particularly as he has noted that interest rates and the costs of servicing debt will have to rise some time.
But Canadians have little heeded the warnings. Household debt to disposable annual income is already at an all-time high of 153 per cent and Carney now expects it will continue to increase.
Carney also stated that house prices are likely to remain elevated, in part because low mortgages are making even high-priced homes affordable to many Canadians.
Last week, the Bank of Montreal led a race to the bottom on interest rates by dropping its promotion fixed five-year mortgage to an ultra-low 2.99 per cent.
How much the central bank is worried about the problem will become clearer on Wednesday when it releases its monetary policy review -- the latest forecast of the global and Canadian economies -- but in Tuesday's announcement, both issues were flagged.
"Very favourable financing conditions are expected to buttress consumer spending and housing activity," the policy council said. "Household expenditures are expected to remain high relative to GDP (gross domestic product) and the ratio of household debt to income is projected to rise further."
The difficulty Carney faces in raising rates, said CIBC senior economist Peter Buchanan, is that clamping down on borrowing applies more brakes on an already slow-moving economy.
As well, since the U.S. Federal Reserve has signalled it's on hold with an even lower interest rate setting, Carney would need to see robust economic activity in Canada to risk a rate increase that would have the effect of boosting the dollar.
"The bank is sitting on the fence until 2014 (because) if anything the statement was a bit more dovish than we were expecting," Buchanan said.
The bank said it now expects the economy to grow by two per cent in 2012, one notch higher than its previous forecast, although the rate of growth is slower. That's because growth in the second half of 2011 was higher, leading to a stronger hand-off to the new year.
The higher starting point also means the output gap -- the measure of when the economy is running on all cylinders -- will close three months earlier than expected, in the fall of 2013, the bank said.
When all the data is in, the bank said growth last year will average 2.4 per cent, three-tenths more than previously anticipated. It now expects growth in 2013 to average 2.8 per cent, one tick lower.
But the bank's mind is clearly focused on external risks, particularly Europe. It said it expects European leaders will be able to prevent credit contagion from spreading, but it warns the risks are increasing.
"The recession in Europe is now expected to be deeper and longer than the bank had anticipated," it said.
"The bank continues to assume that European authorities will implement sufficient measures to contain the crisis, although this assumption is clearly subject to downside risks."
Elsewhere, the bank acknowledges U.S. growth has been stronger, but China is decelerating to more sustainable levels.
The bank remains sanguine about inflation risks, although it said consumer price growth for this year will be slightly higher than it thought. Still, it judged: "Inflation expectations remain well-anchored."
The World Bank, in a new forecast, also said Tuesday that it believes the global economy is braking, both within the emerging and developed economies. Global growth will average only 2.5 per cent this year, the institution said in a statement from Beijing, with the developed world crawling along at 1.4 per cent.
