OTTAWA (Reuters) - Canada's central bank chief entertained the possibility of a U.S. recession and warned on Thursday that global policymakers have some "very hard work" ahead of them to resolve financial market troubles.
David Dodge, who steps down as Bank of Canada governor at the end of this month, also said Canada's economy would slow sharply as U.S. demand for its exports wavers, justifying the need for further "measured" interest rate cuts in Canada.
But he said Canada also has unique advantages that would keep it out of recession. The bank sees Canadian growth slipping to 0.6 percent in the first quarter, down from a previous estimate of 2 percent, but then picking up speed later in the year.
In its quarterly monetary policy report, the bank slashed its U.S. growth outlook for the first half of this year to an annualized 0.5 percent and to 1.5 percent for the full year, down from 2.1 percent previously.
But Dodge said repeatedly said that best guess could easily be proven optimistic as events unfold.
"Could U.S. growth be lower than half-a-percent? Could it be negative-half, or negative-1 percent in the first half? Sure," Dodge told reporters.
Two quarters of economic contraction would constitute a recession but Dodge stressed that the bank's forecast was not necessarily "cooked up with a huge degree of precision."
"This is a very weak U.S. economy and if you look at U.S. final domestic demand, which is really important for us here in Canada, because that's what's determining how many imports they are going to take in, U.S. final demand is actually weaker than that 0.5 percent."
Volatility in world financial markets is far from over, he cautioned. His parting words to central bank colleagues around the world?
"Let's be frank, it's going to take a while to work through that, for some of the excesses in global financial markets to be worked off," he said.
"Most importantly, it's going to require continuing and very hard work globally among central banks and ministries of finance ... We've gone through it before and we'll come through this one as well."
Despite the tough outlook, he downplayed the possibility of a bolder, 50-basis-point rate cut by the Bank of Canada and would not speculate on whether the bank might move rates before its next scheduled policy announcement on March 4.
"I think moving in a measured fashion is certainly, most normally, the right way to operate and that's how we've tried to operate," he said.
Shortly after the U.S. Federal Reserve lowered its rate by 75 basis points on Tuesday, the Bank of Canada shaved just a quarter-point off its overnight rate to 4 percent.
In the past decade, the bank has only changed rates once outside of regularly scheduled dates, and it would be a very tough call for the incoming governor, Mark Carney, to make that his first move.
Canada stands on firmer economic ground than the United States, its top trading partner, largely because of strong demand for its oil and for the other commodities it produces. Credit markets have not tightened as much since the August credit crunch and the economy began the new year running above capacity and with a strong labor market.
Still, borrowing costs for firms and households are roughly between 40 and 50 basis points higher than the bank's overnight target rate, which now stands at 4 percent.
The bank could afford to cut rates without fear of fueling inflation because core inflation, which excludes volatile items, is now seen dipping as low as 1.3 percent in the second quarter before moving back up to the 2 percent target by the end of next year.
Total inflation, however, will stay closer to the target through 2008 and 2009.
In unusually explicit guidance on foreign exchange, the bank said a Canadian dollar worth 98 U.S. cents -- or about C$1.02 per U.S. dollar -- was about right.
It said it was assuming the currency would stay around that level -- approximately where it has been trading this week after declining from a sharp spike to more than US$1.10 in November. "This level is not inconsistent with fundamental factors," it said.
Additional reporting by Toronto money desk; Randall Palmer and David Ljunggren in Ottawa; Editing by Peter Galloway