Bank of Canada: degree of untapped potential remains in economy

By David Ljunggren

KINGSTON, Ontario (Reuters) - A degree of untapped potential remains in the Canadian labor market meaning the economy may be able to generate more growth without higher inflation, the head of the Bank of Canada said on Tuesday, suggesting the central bank can take its time raising interest rates.

While rates are likely to move higher over time, Bank of Canada Governor Stephen Poloz said, the central bank cannot take a mechanical approach as policymakers cannot know in advance how far the capacity-building process can go but have an obligation to let it occur.

Although the labor market has become healthier over the past year, there is still some slack, Poloz said. Increased investment by existing and new companies and more jobs turnover should create more supply in the economy through higher productivity and employment, he said.

As this process involves upside and downside risks to inflation, the central bank will remain particularly data-dependent, Poloz said.

"If the economy builds more supply than usual, that will put downside risk on inflation; if less, that will create upside risk to inflation, and it is our job to balance those risks," Poloz said in a speech.

The bank has raised rates three times since July and Poloz reiterated it will remain cautious in considering future moves. The Canadian dollar weakened against the greenback following the speech.

"This sticks with their mentality that they can be gradual in raising rates," said Josh Nye, economist at Royal Bank of Canada.

"The emphasis on the economy having more room to run without generating inflationary pressure gives it a dovish tone overall."

Poloz said Canada is in the "sweet spot" of the economic cycle where companies will need to hire in order to boost sales.

Despite Canada's low unemployment rate, a wider range of labor market indicators point to "a degree of untapped supply potential in the economy," Poloz said.

"This is important, for it means that Canada may be able to have more economic growth, a larger economy, and therefore more income per person, without generating higher inflation," he said.

Young people, women, recent immigrants and indigenous people are all sources of untapped potential that could increase the labor force by half a million workers and increase Canada's potential output by as much as 1.5 percent a year, Poloz said.

(Reporting by David Ljunggren in Kingston, writing by Leah Schnurr and Dale Smith in Ottawa; Editing by David Gregorio and Diane Craft)