Bank of Canada should raise rates in late 2013-IMF

Wed Dec 19, 2012 9:59am EST

* IMF says BoC should resume modest tightening in late 2013

* Projects growth of under 2 pct in 2013, 2.25 pct in 2014

* Says U.S. fiscal cliff, European crisis biggest threats

* Warns on household debt, says tighter policies may be needed

By Claire Sibonney

TORONTO, Dec 19 (Reuters) - Canada's economy should finally ramp up next year following a couple years of sluggish growth, allowing the Bank of Canada to resume raising interest rates by late 2013, the International Monetary Fund said on Wednesday.

In a report that warned about the threat to the Canadian economy from the U.S. "fiscal cliff," a worsening euro zone debt crisis, and high levels of household debt, the multinational agency said real economic growth slowed this year, and it expects it to pick up to just below 2 percent in 2013 and 2.25 percent in 2014.

Next year, the IMF said it expects growth at a pace slightly above potential from the second half of the year, following more certainty in the United States, Canada's largest trading partner, through stronger exports and business investment.

The IMF approved of the Bank of Canada's current accommodative stance - its key interest rate sits at a below-inflation 1 percent - and said the next gradual monetary tightening should start in late 2013, when growth begins to pick up again.

The report cautioned, however, that "if household imbalances continue to build up in the context of modest growth, further macro-prudential measures should be taken into account before considering an earlier start of monetary tightening."

It welcomed the tighter mortgage rules introduced earlier this year and said that if the economy were to weaken significantly, there was still room for further monetary easing.

The IMF's recommendation is similar to the median view in a recent Reuters poll that expected the Bank of Canada - still the most hawkish Group of Seven central banks - to resume raising interest rates in the fourth quarter of 2013.

If the U.S. "fiscal cliff" remains unresolved - which many economists say could push the United States back into recession - the IMF estimates that the impact on Canada would be around 75 percent of the effect on the U.S. economy.

On the domestic front, the IMF noted a cooling housing sector and cautioned that international headwinds for Canada's exports and commodity-driven economy would be exacerbated by the high levels of household debt. It warned that households might be forced to deleverage in the face of tighter financial and economic conditions.

It said, however, Canada should avoid a housing crash like the one recently experienced by the United States.

While praising a sound banking system that helped Canada weather the global recession better than many of its industrialized peers, the IMF noted that Canadian banks are not immune to financial troubles abroad and that the low interest rate environment would make profit growth challenging. It also called for further steps to build on the strength of the financial system.

The agency also warned that the low interest rate environment would weigh on the non-bank sector such as pension funds, which may require higher contributions.

Earlier this week, Canada's finance minister agreed to set economic benchmarks for expansion of the country's public pension system in the future, but said the economy was too weak now to demand bigger contributions from businesses and workers.

The report said the government should continue to address long-term spending pressures. It said that Ottawa's plans to balance the budget by 2015 are "well within reach," but that deficit-cutting may prove more difficult for some of the largest provinces. In the event of big negative shocks from abroad, the IMF recommended the federal government to consider more fiscal stimulus.

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