January 22, 2009 / 4:04 PM / 9 years ago

Canadian recession to be steep but short: BoC

4 Min Read

<p>A worker prepares to install a battery into a Ford Flex on the assembly line at the company's Oakville Plant in this June 3, 2008 file photo.Fred Thornhill</p>

OTTAWA (Reuters) - Canada's recession will be harsh but shorter than previous ones, Bank of Canada Governor Mark Carney said on Thursday, laying out a scenario for recovery that some economists considered overly optimistic.

Signaling the economy is now in the most dramatic phase of its downturn, the bank projected a sharp 4.8 percent contraction, annualized, in the first quarter. Just last October it forecast the economy would stay flat in the first quarter, neither growing nor contracting.

Gross domestic product likely shrank by 2.3 percent in the fourth quarter of last year, the bank said, and will decline by 1 percent in the second quarter of this year before returning to growth.

"The projected return to balance of the Canadian economy is faster than either of the recoveries following the 1981-82 and 1990-92 recessions," the bank said in its quarterly economic outlook.

It said the economy would not ramp up to its full potential again until mid-2011, but this would be about a year faster than in the past, partly because the central bank was able to slash interest rates early and aggressively without fear of inflation expectations becoming unhinged.

"Part of it is that monetary policy is very stimulative and it was stimulative early," Carney told reporters. "We've acted and we will continue to act, if necessary, so we provide a considerable stimulus."

On Tuesday, the bank dropped its overnight rate by one-half point to a 50-year low of 1 percent for a cumulative reduction of 350 basis points since December 2007.

The bank's view on the speed of the recovery is "open to debate," said Doug Porter, deputy chief economist at BMO Capital Markets.

Derek Holt, economist at Scotia Capital was more hard line: "I would love for them to be right but I think they're wide-eyed optimists right now," he said.

Fiscal Stimulus

Carney argued that Canada's economy entered the recession on a stronger footing than in the past and that the combined fiscal expansion by governments around the world would have a multiplier effect on Canada's export-reliant economy.

Canada's government is set to announce stimulus measures estimated to be worth about C$30 billion ($24 billion) on Tuesday. Carney said the Bank of Canada has assumed a "substantial" fiscal stimulus from the government in its forecasts, without providing details.

In the United States, Canada's top trading partner, President Barack Obama brings political capital that may enable him to take "significant, bold and timely" action to resolve the financial crisis -- which would have an impact on Canada, Carney said.

The congressional testimony this week by Timothy Geithner, Obama's nominee to head the U.S. Treasury, had provided some sense of that, he said.

The bank could comfortably cut rates further because it expects falling prices in the second and third quarters, while believing the risk of deflation to be "remote." Core inflation, which excludes volatile items and guides rate decisions, will remain within the bank's desired 1-3 percent range, he said.

But in the event that it did have to cut rates all the way to zero, Carney said the bank has contingency plans for unconventional policy measures.

"We obviously talk with our colleagues in the U.S., Japan and other jurisdictions that are looking at various options, so we're familiar with their potential applicability to Canada," he said.

Credit conditions in Canada remain better than in other major economies and although credit to both businesses and households will tighten, it will continue to grow, Carney said.

"That has been incorporated in our projection, that expectation that there will be a slowing of credit growth in Canada," Carney said.

($1=$1.26 Canadian)

Editing by Peter Galloway

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