Despite risks posed by the recent turmoil in stock markets, the Canadian economy is running hot and may need still higher interest rates to cool things down, the Bank of Canada said Wednesday.

The central bank released its Update to the April Monetary Policy Report, in which it discusses economic and financial trends in the context of Canada’s inflation-control strategy.

The Bank says Canada’s economic recovery, which began in the last quarter of 2001, gathered momentum in the first half of 2002. Over the period to the end of 2003, the Bank projects continued solid economic expansion at an annual rate of 3% to 4%. This will result in growth of close to 3.5% on an annual average basis in 2002 and in 2003.

Both the total and core rates of inflation are projected to be slightly above 2% in the second half of 2002, before steadying out at close to 2% in 2003.

The Bank says that there is now less excess capacity in the Canadian economy than it projected in its April Report. The economy is expected to be operating at full capacity in early 2003 — sooner than previously anticipated by the Bank.

In light of these developments, the Bank says it has continued to reduce the amount of monetary stimulus in the economy. The central bank has raised the target for the overnight interest rate by 25 basis points on three occasions — in April, June, and July — to bring the rate to 2.75%.

The Bank left no doubt that will continue to raise rates, saying, “The underlying economic situation will require further reductions in the amount of monetary stimulus. The timing and pace of policy adjustments will depend on the strength of the various factors at play and their implications for pressures on capacity, and thus on inflation.”

The Bank’s update outlines upside and downside risks to the outlook for Canadian economic growth. On the positive side, it says growth of domestic demand could turn out to be stronger than projected because of the substantial amount of monetary stimulus still in place.

On the negative side, the Bank says it is worried about what effect the uncertainties associated with global corporate and financial market could have on confidence and world economic growth.

The Bank says it remains committed to achieving the 2% inflation target. It says that keeping inflation low and stable is the best contribution that monetary policy can make to sustained economic growth in Canada.

http://www.newswire.ca/releases/July2002/24/c7470.html