The Bank of Canada sees a greater risk of recession in Canada than it did just one month ago as the global financial crisis ripples through the economy, Governor Mark Carney said on Wednesday. In a speech in London, Carney repeated that the central bank would likely have to cut its key interest rate further to keep the export-reliant economy afloat in the face of a global recession and what he called a "consumer recession" in the United States, its top trading partner.
"Starting from flat growth in the first quarter of 2009 and the second quarter of 2009 ... recession is a possibility for Canada. We do see growth picking up in the second half of 2009," he said at a news conference following the speech.
In the central bank's latest outlook in October, it forecast the economy would grow 0.8 percent in the third quarter of this year before contracting 0.4 percent in the final quarter and staying flat in the first quarter of next year. The economy was already stagnating in the first half of 2008.
The bank also said last month it would likely need to cut its overnight lending rate further, but said the risks to its outlook were balanced. On Wednesday, Carney shifted to an even more dovish stance. "While domestic demand in Canada remains relatively healthy and the depreciation of the Canadian dollar will offset some of the declines in external demand, the risks to growth and inflation identified in the October Monetary Policy Report appear to have shifted to the downside," Carney said.
The Bank of Canada has reduced its key lending rate by 225 basis points since December. The rate is now 2.25 percent. Outlining the lessons from the global credit crisis and the reforms needed to mitigate future crises, Carney emphasised the risks that come with a push away from market-based finance toward bank-based finance. He specifically warned regulators against exaggeration when increasing capital requirements at a time when capital is scarce, for fear of worsening the economic downturn.
"Regulators should be careful about pushing capital standards up too high, too soon in the teeth of an economic slowdown," he said. In a range of countries, he said the healing process needed to be managed very carefully as the need for higher capital levels could lead banks to hoard new capital rather than expand lending again, putting additional strain on the system.
There is a "pressing need" for an international bodies to monitor risk in the global financial system and to co-ordinate the regulatory policy response, he said. The International Monetary Fund has a central role to play in assessing individual countries' financial regulations and holding them accountable, Carney said.
He said it was up to the Canadian government to decide whether to increase its funding of the IMF through Special Drawing Rights, after the lender said it needed an additional $100 billion as it comes to the rescue of several troubled economies around the world. "There are other ways to get additional resources to the fund, including permission to borrow," he said. "There are ongoing discussions."
He said the focus of any new regulatory approach globally should seek to address three flaws in market structure: lack of transparency, misaligned incentives and inadequate liquidity. He said he was opposed to outright regulation of compensation.
The action plan laid out last month by the Group of Seven industrialised nations, which made it clear that they will not allow any systemically important institution to fail, will take time but will be successful, he said. He expects Canadian banks will cascade liquidity, provided by the central bank and government, through the system but said that was not yet the case in other countries. A second strategy for rebuilding credit markets involves central banks ensuring market transactions continue by acting as counterparties to major players.
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