01/18/2012 12:23 EST | Updated 03/19/2012 05:12 EDT

Bank of Canada says Europe will drag on growth

The Bank of Canada says an intensifying European debt crisis is holding back growth in both the domestic and world economies. It forecasts that the crisis will curb Canadian economic growth by about 0.6 per cent this year, equivalent to about $10 billion in lost GDP.

The calculation marks the first time the bank has attempted to put a hard number on the spillover effects of the European sovereign debt drama.

In its latest monetary policy report on Wednesday, the central bank predicted Europe’s recession will last most of 2012, longer than it had predicted in its October report.

The bank said the debt crisis will not only cut into the growth in world trade, but also indirectly affect financial conditions, confidence and commodity prices.

The report came a day after the bank once again kept its key interest rate unchanged at 1.0 per cent.

It also predicted the eurozone crisis will shave more than one per cent off the global growth rate by the end of 2012 and 0.8 per cent from the United States’s previously projected expansion.

The bank estimated that Canada’s economy grew by 2.4 per cent in 2011 and projected that it will grow by 2.0 per cent in 2012 and 2.8 per cent in 2013. That compared with its projection in October for 1.9 per cent growth in 2012 and 2.9 per cent in 2013.

It called for inflation to moderate this year and then rise, reaching two per cent by the third quarter of 2013.

The bank once again sounded the alarm on high levels of Canadians’ personal debt.

"High household debt levels in Canada could lead to a sharper-than-expected deceleration in household spending," it said.

"If there were a sudden weakening in the Canadian housing sector, it could have sizable spillover effects on other areas of the economy."

The report included a revision from the bank's October outlook for growth in the U.S. economy in 2013, to 2.2 per cent, compared with its earlier projection of 3.3 per cent.

Report spurs speculation on interest rates

TD Bank economist Diana Petramala said the report suggests the bank will not raise interest rates this year.

“The central bank is unlikely to want to raise rates in an environment where global financial conditions are worsening,” she said in a commentary.

But Michael Gregory, senior economist with BMO Capital Markets, saw it differently, given the report’s mention of “a gradual reduction in monetary stimulus over the projection horizon.”

Gregory said with the bank’s expectation that Canada’s economy would be at full capacity by the fall of 2013, “we are bracing for some degree of rate hikes (no matter how modest) starting by the middle of next year.”

“It’s only a matter of time,” he said.