Although oil prices, the loonie and interest rates are all headed higher, Canadian consumers are keeping their chins up, says the Bank of Canada.

Households seem to be faring well, thanks to a growing economy, central bank governor David Dodge said Thursday in his latest economic outlook. "Consumers are in a relatively good mood," Dodge told a news conference. "We expect household incomes to continue to rise. . .continued growth of employment. . .(so) we expect household consumption to continue to make a very significant contribution to growth."

Dodge spoke two days after the central bank raised its key policy interest rate by a quarter-point to 2.50 per cent - its second such increase in as many months.

And more rate hikes are coming "over time" with the pace depending on the strength of monthly economic data, Dodge added.

"(Our) base case projection assumes further reduction of monetary stimulus (higher interest rates) over time," he said.

"The pace. . .really is going to depend on developments as they unfold."

After cutting rates early this year to stimulate growth, the bank shifted gears when it saw how quickly the economy was expanding.

Growth hit a surprising 3.7 per cent in the first half, thanks to strong global demand for Canada's goods as well as robust household and business demand at home.

Expensive oil is likely to act as a drag next year, Dodge warned.

But growth should continue at just under three per cent next year and just above three per cent in 2006, he said.

The bank cut its 2005 forecast from the 3.5 per cent predicted in the summer.

That doesn't imply a slowdown but instead merely reflects the surprising growth in the first half, which raises the base level of GDP growth, said Dodge.

And that makes it clear rates are headed up, analysts said.

"With the Canadian economy operating very close to full capacity. . .(the bank) left no doubt whatsoever that it still expects to be raising rates over the course of the next 12 to 18 months," said Marc Levesque, chief fixed income strategist with TD Securities in Toronto.

"(But) there is no need to scramble. . .the bank still sees itself as having a fair amount of wiggle room on the interest-rate front."

It's still not clear whether rates will go up again at the bank's next scheduled announcement date Dec. 7, or if central bankers will wait until early next year.

Much will depend on how the global economy handles gathering storm clouds, said Dodge.

High oil prices, a possible slowdown in the voracious Chinese economy, current-account imbalances in the United States and East Asia and other geopolitical developments could all hurt growth.

But even as rates rise, Canadian households seem strong enough to cope, he added.

"We don't think there is a great deal of vulnerability for the household sector as a whole," said Dodge, although some individual households "may be more exposed than others."

New retail sales data released Thursday supports that opinion.

Gains of 0.8 per cent in August sales beat analyst projections and reflect a healthy consumer sector.

Meanwhile, the strong dollar, which popped above 80 cents US Wednesday for the first time in more than 11 years, has also been a positive for the economy, added Dodge.

The loonie has climbed in reaction to world events that have been good for Canada, such as strong growth which fuels demand and higher prices for commodities, said Dodge.

"The exchange rate has been reacting to real factors. It hasn't been something that has been levitating on its own."

Following Dodge's remarks, the dollar gained 0.21 cents to reach 80.50 cents US by early Thursday afternoon.

While a strong dollar might slow exports, it makes imports cheaper and helps reduce inflation.

Still, the central bank expects core inflation - which excludes volatile food and energy prices - will reach the bank's target of two per cent by the end of next year.

The core rate has a ways to go, running at just 1.5 per cent in August.

Meanwhile, higher oil prices could push overall inflation over three per cent by next year before it settles back to about two per cent, the central bank added.

And while it usually sees strong oil prices as an overall positive factor for Canada, since so many energy firms are based here, that won't likely be the case in 2005, the bank added.

"The positive impact of higher oil prices on energy-producing firms is likely to be limited in the short term," because companies may run into shortages of material and labour, said their report.

"Thus, the bank projects that high oil prices will be a small net drag on the economy in 2005."

Oil prices, which have been running in the $55 US per barrel range, will stay high, averaging about $50 US per barrel in the first half of next year before easing to about $43 US per barrel in the second half of 2006, the bank projects.

That will chill world growth and slow the U.S. expansion to about 4.5 per cent this year, 3.75 per cent in 2005 and around four per cent in 2006.

Meanwhile, global growth - driven by a booming Chinese economy - should average 4.7 per cent this year, slowing a bit to 3.9 per cent in 2005 before rising back up to 4.3 per cent in 2006.

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