By Nicole Mordant
VANCOUVER (Reuters) - The Bank of Canada remains concerned about tepid business investment, a key official said on Tuesday, adding it is too early to assume the worst of underperformance is over despite stronger-than-expected economic growth recently.
Deputy Governor Lawrence Schembri said sluggish business investment and a shift toward protectionist trade policies in the United States are the two biggest downside risks to the bank's inflation outlook, reiterating that material slack remains in Canada.
He said the bank still expects the output gap will close around mid-2018, which many see as the point at which monetary accommodation will no longer be needed and the bank could start to raise interest rates.
"As we see progress being made on a sustained basis to closing that output gap, then we'll start looking at the decision to raise rates," Schembri said in response to a question after the speech.
"But at the same time, we have to take into account there are these downside risks that I've talked about and they could slow down the rate at which we close the output gap, so that would affect our decision."
Governor Stephen Poloz said in January that a rate cut was not yet off the table. But stronger-than-expected growth in jobs, exports, and retail sales since then have boosted market confidence for an eventual rate hike, rather than a rate cut.
While fourth-quarter GDP data came in "somewhat stronger" than the bank anticipated in January, Schembri highlighted the divergence in both growth and monetary policy between Canada and the United States, where "U.S. authorities have now begun to tighten" interest rates.
"While the headline (GDP) number is welcome news, a more detailed analysis suggests continued scope for caution. Exports continue to face ongoing competitiveness challenges," Schembri said in prepared remarks to the Greater Vancouver Board of Trade.
Schembri said that growth in the United States is expected to remain solid, supported by robust fundamentals, including a strong labor market with gradually rising wages.
He also reiterated the bank's standard language on elevated housing prices in Vancouver and Toronto, pointing to supply constraints and some impact from foreign demand, while warning that high debt leaves some households vulnerable in the event of a big negative shock like a spike in unemployment.
On the upside, stronger U.S. growth and higher commodity prices were upside risks to the inflation outlook, Schembri said, potentially boosting Canada's terms of trade and business investment.
(Writing by Andrea Hopkins; Editing by Chizu Nomiyama and Lisa Shumaker)