November 19, 2008 / 2:09 PM / in 9 years

Bank of Canada chief sees recession risk growing

<p>Governor of the Bank of Canada Mark Carney delivers a speech before the Canada-United Kingdom Chamber of Commerce in central London November 19, 2008. The Bank of Canada sees a greater risk that economic growth and inflation will be lower than it projected just a month ago as the global financial crisis ripples through the domestic economy, Carney said on Wednesday. REUTERS/Alessia Pierdomenico</p>

LONDON (Reuters) - The Bank of Canada sees a greater risk of recession in Canada than it did just one month ago as the global financial crisis rips 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 benchmark 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, Canada’s 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. Canada narrowly avoided slipping into recession in the first half of this year.

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,” he said.

CANADIAN DOLLAR EASES

After the speech, the Canadian dollar eased. Later it extended its decline to its lowest level since October as fears of a deeper global recession and the fate of the North American auto industry fueled a surge in the U.S. currency.

TD Securities reacted to Carney’s speech by upholding its forecast of an interest rate cut of 50 basis points to 1.75 percent on December 9 and noted a “significant risk” that the rate could go even lower at a later date.

“In turn, one is left with the conclusion that not only will the Bank of Canada likely cut rates, but that it may feel obliged to do so somewhat forcefully,” it said in a note.

Carney said a debt default of one of the top three North American automakers would have a major impact on Canada, and it would take such a possibility into account when setting rates.

The Bank of Canada has reduced its key lending rate by 225 basis points since December. The rate is now 2.25 percent.

Analysts widely expect another cut on December 9. Even so, the extent of any further moves to ease borrowing conditions is unclear and investors are reluctant to bet heavily on Carney, who has surprised them in the past.

The governor is unapologetic about not telegraphing his every move to markets. He said it made sense for there to be a range of views on monetary policy during times of major uncertainty. “It can’t be mechanistic,” he said.

“DO WHAT‘S RIGHT”

Later on CNBC television, Carney said central banks ought to weigh the inflationary impact of deep interest rate cuts being delivered to tackle the world economic slowdown. But having done so, policy-makers must ultimately must “do what’s right,” he said in the interview, which aired in London.

He said the round of globally co-ordinated interest rate cuts in October was effective, but said not to necessarily expect central bankers to follow up with a second round.

“These co-ordinated interest rate cuts ... are extremely rare and that reflected rapid change in the economic situation,” he said.

Carney said governments should consider more fiscal steps to stimulate their economies, following China’s $586 billion package of infrastructure projects and other measures to revive growth.

“We’ll see what the Canadian government decides in the course of the next couple of weeks as they do their equivalent of that,” he said.

CAUTION ON CAPITAL REQUIREMENTS

Outlining the lessons from the global credit crisis in his speech, Carney emphasized 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.

Additional reporting by Jamie McGeever; editing by Rob Wilson

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