Senior deputy governor of the Bank of Canada, Paul Jenkins, reiterated the central bank’s prediction of modest interest rate rises in a speech to the Saint John Board of Trade today.

Jenkins repeated the views expressed in the most recent Monetary Policy Report update, noting that, “the Canadian and world economies have been evolving in line with our expectations”, “We also point out that the Canadian economy continues to adjust to global developments and to the associated changes in relative prices.”

It predicts that world economic growth will remain robust — around 4% this year and next. “Against this backdrop, our assessment is that the Canadian economy as a whole is currently operating at its production capacity,” he said. “And we expect it to keep on growing roughly in line with its production potential through 2007. Specifically, we project annual average growth of 3.1% this year and 2.9% in 2007.”

He noted that there are both upside and downside risks to its projections. “For 2006, the risks relate to the world economic outlook and the adjustment of our economy to global developments. These risks appear to be balanced. But through 2007 and beyond, the risks are tilted to the downside as the unwinding of global imbalances could involve a slowdown in world economic activity.”

“With our economy operating at capacity and expected to grow roughly at potential through the projection period, on January 24 we raised the policy interest rate by another 25 basis points to 3.5%. And we indicated that, in line with our base-case projection and current assessment of risks, some modest further increase in the policy interest rate would be required to keep aggregate supply and demand in balance and inflation on target over the medium term.”

Jenkins said that large global fiscal imbalances are not sustainable over the longer run. “No country, even one as big as the United States, can keep increasing its external indebtedness as a share of its GDP. Ultimately, these imbalances will have to be resolved,” he suggested.

“Part of the solution involves an increase in U.S. national savings. But higher U.S. savings means lower U.S. consumption, which would likely mean lower Canadian exports to the United States. To avoid the dampening effect that lower U.S. spending could have on overall global demand, other industrialized countries need to adopt policies that promote stronger domestic demand,” he noted.

“But this won’t be enough,” he added. “This shift towards greater domestic demand growth in Asia will not come about smoothly if those countries currently operating under fixed or tightly managed exchange rates do not begin to promote greater nominal exchange rate flexibility.” If this does not happen, Jenkins said there’s a risk that countries with floating exchange rates may have to bear more than their fair share of the burden of resolving the imbalances. There is also a risk that protectionist measures could be taken worldwide, hurting all trading nations, including Canada, he said.

“For many firms and individuals, adapting to global change has been difficult and, in some cases, painful,” Jenkins added. “All of us understand the challenges they face. Encouragingly, evidence from the Bank’s quarterly surveys confirms that across Canada businesses have been responding to the new global economic realities. Some have chosen to import more inputs and finished goods from lower-cost suppliers in Asia. Others have moved away from products and markets with low profitability towards those that are likely to yield higher profit margins. And firms have been investing in machinery and equipment to increase their productivity.” He emphasized that the Bank intends to facilitate this process by maintaining price stability.