Bank of Canada once again faces the dilemma of a two-speed economy: Don Pittis

In some ways, it's like Dutch disease all over again, and just like before, the current two-speed economy in Canada hasthe potential to exacerbate nationaldivisions.

Dutch disease, famously diagnosed in this country by the NDP'sThomas Mulcairin 2012 and for which the Opposition leader was roundly attacked set supporters of the booming oil and gas sector against those in the crumbling industrial parts of the country.

The difference is that now, the shoe is on the other foot.

"The impact of the decline in oil prices is at the heart of this update," Bank of Canada governor Stephen Polozsaid yesterday, as he explained to reporters why he was slowing the pace of interest rate increases, holding the Canadian headline rate at 1.75 per cent.

But that rate is to some degree a compromise. While rising wages and economic growth in some sectors and regionscould sustain higher rates, the energy sector might be better off with interest rate cuts.

According to the Dutch disease scenario, surging oil exports drove the Canadian dollar higher, pricing Canadian industrial products out of their traditional markets. Jobs and wages in places like Alberta surged. In Canada's former industrial heartland, unemployment grew as companies closed their doors.

Of course, energywasn't alone in leading Polozto hold off ona rate hike. Fear of a shrinking global economy, caused to a large extent by fears of a growing trade war between the U.S. and China, also contributed to the decision.

The economy continues to be dogged by global uncertainties, includingBrexit's potential impacton Europe. There is also the unknownfate of thetrade deal Canada negotiated with the U.S. and Mexico, which has Canadian businessesanxious and holding onto their money.

"Unfortunately there doesn't seem to be any place to hide from uncertainty," Poloz said.

A slowdown in the pace of interest rate hikes would also help over-borrowed Canadians facing rising rates on loans and mortgages, giving them longer to adjust. However, the bank has no plans to roll back the stress teststhat ensure Canadians are able to handle any future rate increases.

In fact, while Polozonce again said the future path of interest rates would depend on the data pointing to yesterday's delay in further increases as evidence of the bank's flexibility he insisted that rateswould eventually continue to rise.

Rates expected to keep rising

At 1.75 per cent, he says, rates are still low enough to addstimulus to the economy. They will continue to rise until they reach a neutral point where they neither stimulate nor slow the economy.

"The best estimates we have right now are sort of in the 2 to 3 range," he said. In effect, most mortgage holders must plan for a rate increase in the order of another whole percentage point.

One of the reasons for that expectation, Polozsaid, isthat gloom about the economy isoverdone.

For one thing, while there is a risk of economic trouble due to the U.S.-China trade dispute, a resolution of that dispute could lead to a rebound in the world economy and increase demand for oil, whichtends to rise and fall with economic expectations.

And despite trouble in the oil and automotive sectors,both sectors combined represent only about fiveper cent of the Canadian economy, and both have been shrinking. Theyjust aren't as big an influence on Canada's industrial economy as they once were, and they are being upstaged by things such asinformation technology and the service industry.

"It's important to understand that there are a lot of other things going on out there that areactually doing really well,"Polozsaid. "Just in a sector such as IT services, which is growing at five, sixor sevenper cent a year, the leading growth job creator, the leading export category, leading in many respects."

Ninety per cent of the economy, he says, is operatingat capacity and having trouble finding workers. While oil sector wages are barely keeping up with inflation, wages in othersectors and regions are rising at close to three per cent.

Creative destruction

The Bank of Canada governor said the idea of creative destruction, proposed by economist Joseph Schumpeter in the 1940s, where young industries grow up to replace old ones that decline, is happening now in this country, including in the oil sector that so recently dominated the Canadian economy.

"The oil sector is a great example," he said, citing an industry that grew faster than all others from 2008 to about 2014. "But what was happening in the rest of the economy? Many places were being crushed by exchange rates that were at parity or above."

Polozsays the bank will have a better idea of where the economy is heading in the spring. One thing he will be watching for is whether the economy's capacityits ability to grow without inflationis increasing.

"What it could mean is that there is less capacity in the oil sector, and that's all right because they are in the process of downsizing, essentially, from that extraordinary level."

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