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Bank of Canada sees neutral interest rate one and a half points lower

The Bank of Canada building is pictured in Ottawa March 3, 2009. REUTERS/Chris Wattie

OTTAWA (Reuters) - Interest rates may have to be about 1-1/2 percentage points lower than they used to be historically to enable the Canadian economy to operate at full capacity, the Bank of Canada said on Monday in a major policy pronouncement. The central bank estimated that the neutral rate of interest, at which the economy can work at full capacity with stable inflation, is 3 to 4 percent, down from 4-1/2 to 5-1/2 percent in the mid-2000s. And it is possible that persistent headwinds might mean that rates have to be lower than the neutral rate even after the output gap has been closed, to keep inflation on target. Senior Deputy Governor Carolyn Wilkins cited as reasons the fact that potential output will be lower than in the years leading up to the crisis, combined with higher global savings and new financial regulations requiring more safe assets. "All told, we think that the neutral rate of interest is lower than it was in the years leading up to the crisis because of these structural developments," she said in a speech in Toronto. The text was made available in Ottawa. Wilkins said current policy needed to continue to be stimulative, relative to the neutral rate of 3 to 4 percent, in order to close the output gap. "But even with a closed output gap and inflation at target, the policy rate may not be neutral. As long as the factors leaning on growth persist, a policy rate below neutral would be required to maintain inflation sustainably at target," she said. (Reporting by Randall Palmer and Leah Schnurr)

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