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Bank of Canada official says NAFTA uncertainty keeps interest rates low

The Bank of Canada has kept interest rates low partly because of the uncertainty around U.S. trade policy, Deputy Governor Lawrence Schembri said, suggesting that a resolution of negotiations over the North American Free Trade Agreement could open the way for higher rates.

Speaking at an event in Ontario, Schembri said the Canadian economy is running near its potential, but that concerns related to NAFTA are weighing on businesses' investment decisions as well as export growth.

"Many firms don't have the capacity to expand further without investment and [an] increase in exports. We're seeing this combination of limited capacity and limited export growth, and the capacity is being hindered by firms being reluctant to take on investment in an uncertain environment," Schembri said in response to a question at the event hosted by the CFA Society Ottawa and the Ottawa Economics Association.

"That's part of the reason why we believe that the economy is operating close to potential: Inflation is less than, is close to, our target of 2%, yet monetary policy is below the neutral rate, in part because we have to lean against the drag coming from the uncertainty created by NAFTA," he said.

The bank kept its rates unchanged in April. Rates have been raised three times since July 2017, including a quarter-point increase in January.

Schembri said in his speech that trade liberalization is the "most helpful" remedy for lifting Canada's economic potential, citing the country's trade agreements with the EU and Pacific nations that "are helping reduce barriers and create opportunities for Canadian companies."

"Our history tells us that our firm commitment to trade liberalization will remain important for supporting solid potential growth in the future," the central bank official said.

Schembri also said that the bank's upward revision to its potential output growth rate forecast in April gives policymakers "a bit more room" than previously thought to support demand without sparking undue inflationary pressures.

"The higher the projected growth rate of potential output, the faster the economy can grow without inflation rising persistently above our target," Schembri said.