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OTTAWA, May 31 (Reuters) - The Bank of Canada should keep interest rates low and Canada's federal government should be ready with more fiscal stimulus in the event of an economic downturn, the International Monetary Fund said on Wednesday in a report that reiterated warnings about Canada's hot housing market and high household debt.
In an annual assessment of Canada's economy, the IMF said while it expects the recovery to gain momentum in the near term, risks to the outlook are significant - including a sharp correction in housing and U.S. protectionism.
The IMF staff said the Bank of Canada's cautious approach is justifiable given the "considerable uncertainty" around the economic outlook, and said monetary policy should stay accommodative and gradually tighten as signs of durable growth and inflationary pressures emerge.
"The Bank could aim to achieve a small and temporary overshoot of the inflation target to better manage the downside risks to the inflation outlook and reinforce the symmetry of the inflation target," the report said.
The central bank has held rates steady at 0.5 percent since 2015 in a bid to boost growth in the wake of an oil price slump.
The IMF warned a sharp correction in housing could hurt the nation's banks, which have already been downgraded, trigger negative feedback loops in the economy, and lead to contingent claims on the government.
"Financial stability risks could emerge if the housing market correction is accompanied by a severe recession," the report warned.
House prices in Toronto and Vancouver, the nation's largest markets, have more than doubled since 2009 but signs of a slowdown have emerged in the wake of repeated government moves to tighten mortgage lending and the introduction of a foreign buyers tax in those two cities.
Still, the IMF said a further tightening of macroprudential and tax-based measures should be considered to mitigate speculative and investment activity.
It said the foreign buyers tax is discriminatory and urged authorities to replace it with rules or taxes aimed at discouraging speculation without targeting non-residents.
While growth is seen rising to 2.5 percent this year as oil prices stabilize and U.S. growth boosts Canada's economy, GDP growth is expected to slip to 1.9 percent next year as stimulus fades and U.S. growth moderates.
The IMF said fiscal stimulus should be the first line of defense if downside risks materialize, because there is a risk further easing of monetary policy could worsen household debt and housing imbalances. (Reporting by Andrea Hopkins; Editing by Andrea Ricci)