Carney says Canadian economy getting worse, hints at further rate cuts (Carney-Economy)

By Julian Beltrame

THE CANADIAN PRESS

OTTAWA _ The Canadian economy is deteriorating faster than previously thought and will require further stimulus, says Bank of Canada governor Mark Carney.

Carney signalled strongly Wednesday that the central bank will reduce short-term interest rates again on Dec. 9 in an effort to boost economic activity.

``Despite having already cut official interest rates in half over the past year and having a financial sector that is still functioning effectively, some further monetary stimulus will likely be required to achieve the inflation target over the medium term,'' he said in notes from a speech to a business audience in London, England.

Carney did not predict Canada would fall into a recession, defined as two consecutive negative quarters of growth. But in admitting that the economy was weaker than projected by the central bank last month, when it forecast a fourth-quarter contraction and meagre 0.6 per cent growth in 2009, he appeared to at least acknowledge a recession is a possible.

Recently, the International Monetary Fund downgraded Canadian growth to 0.3 per cent next year, while several private-sector economists have predicted the economy will in fact shrink in 2009 for the first time in 17 years.

Carney credited Canada's sound banking practices for sheltering the country from the worst of the financial crisis, but added that the country is nevertheless taking a hit from the global slowdown and deep slump in the United States.

Not only have commodity prices tumbled and the availability of credit tightened, he said, but the nature of the U.S. slowdown _ with its pressure points in the housing and auto sectors _ affects key Canadian exports of lumber, vehicles and parts.

``Thus, 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... appear to have shifted to the downside.''

Carney did not offer a new economic forecast, saying only that the risks have increased and that growth in the gross domestic product will come in below 0.6 per cent.

The Canadian economic situation was a sidebar to the main message Carney delivered in London, but it underlined a key point _ that even countries like Canada that have their finances in order were helpless to fend off the carnage from the breakdown in U.S. and global financial markets.

He said many countries must reform their systems, but averting another crisis will also require stronger and more vigilant international institutions, such as an effective International Monetary Fund.

``Even if the domestic system is sound, there is no guarantee that core financial markets will always be available,'' he pointed out.

``There is a pressing need for international institutions that effectively monitor systemic risk and co-ordinate macroprudential and financial policy reform.''

He said the crisis developed in part because of a lack of effective international surveillance.

He said Canada's experience _ with strong asset-to-capital ratios, less securitization of mortgages, and required insurance on risky mortgages _ shows that reforms urged at recent meetings of G7 and G20 leaders would work.

As such, Carney implicitly came down against calls from some quarters for a complete overhaul of the Breton Woods institutions, such as the IMF and World Bank, that have regulated international commerce since the Second World War.

Nor should policy-makers jump at the currently in-vogue proposal to regulate salaries and bonuses in the financial sector, said Carney, whose background is as an investment banker at Goldman Sachs.

But he suggested the cure will not be quick and won't be without pain.

To get key markets such as interbank lending and commercial paper working again, he said, central banks may have to inject enough liquidity to in effect become ``market makers of last resort.''

And the growing importance of bank-based finance following the failure of the market system poses problems of overshooting, he warned.

``We should not want the pendulum to swing too far,'' he cautioned.

He added that higher and desirable requirements for capital by financial institutions could cause banks to ``hoard any new capital rather than deploy it'' by making credit-worthy loans.

``Doing so would worsen the economic outlook, which would then increase loan losses and further strain capital levels,'' he noted.

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