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UPDATE 1-Inflation risks to rise with full output-Bank of Canada's Poloz

(Adds comment from speech, context)

MONTREAL, Nov 7 (Reuters) - The closer Canada gets to full output and employment the greater the risk that inflation pressures will appear, Bank of Canada Governor Stephen Poloz said on Tuesday, reiterating that policymakers will be cautious about future rate moves.

Saying the central bank has a good understanding of what is driving inflation, Poloz said there is still a link between labor market slack and wages, just as there is still a link between inflation and the balance of total supply and demand.

"What this means it that the closer we get to full output and employment, the greater the risk that inflation pressures will appear," Poloz said in prepared notes for his speech.

He repeated the Bank's recent language that while less stimulus will be needed over time, policymakers will be guided by incoming data to assess the evolution of economic capacity, wage growth, inflation, and the sensitivity of the economy to higher interest rates.

"A lot of pieces need to fall into place before we can be certain that the economy has made it all the way home," Poloz said in notes for the speech to financial analysts and the Montreal Council on Foreign Relations.

The Bank of Canada raised rates at back-to-back meetings in July and September but left policy unchanged at its October meeting. Economists are divided over whether the bank will hike again in December or wait until 2018.

Inflation remains well below the 2 percent midpoint of the bank's target range for inflation.

Poloz said a margin of error, short-term fluctuations and forces like globalization and digitalization can explain why inflation has underperformed forecasts, but he said its recent softness does not mean the usefulness of inflation targeting should be questioned.

He said there were several reasons for slow wage growth, noting that "a fair amount of slack" remains in the labor market, with low youth participation, the loss of high-paying jobs in the oil sector, and the replacement of older workers with younger ones.

Poloz also said very low interest rates may have encouraged companies to make greater use of capital equipment, limiting the scope for wage increases.

"At a minimum, we need to monitor measures of slack in the labor market to see how it is being absorbed. Over time, this can be expected to lead to a pickup in wage growth, which in turn will feed its way through to inflation," Poloz said. (Additional reporting by Andrea Hopkins and Leah Schnurr in Ottawa; Editing by Chizu Nomiyama)