March 13, 2008 / 5:19 PM / in 10 years

Bank of Canada says economy hit by credit woes

TORONTO (Reuters) - Canada’s economy is taking a hit from the global credit turmoil and more interest rate cuts are needed even though domestic money markets are healthier than elsewhere, Bank of Canada Governor Mark Carney said on Thursday.

<p>Mark Carney, Governor of the Bank of Canada, speaks before the Toronto Board of Trade March 13, 2008. The Bank of Canada will set interest rates appropriately for Canada, regardless of what the U.S. Federal Reserve does with its key rate, Carney said on Thursday. REUTERS/Mark Blinch</p>

In his second speech since becoming governor on February 1, Carney was careful not to reveal any bias on future monetary policy or in his outlook on the magnitude of the U.S. downturn, referring repeatedly to earlier statements.

The bank’s March 4 statement that “further monetary stimulus” will likely be required in the near term still holds true, he said, but gave no hint as to the size of the next cut on April 22.

When setting interest rates, the central bank will pay more attention to the duration of the U.S. economic slowdown than to whether or not the United States falls into a full-blown recession.

“What’s important for the U.S. outlook, whether it’s just above positive growth, zero, just below positive growth, at this point is less important for the conduct of monetary policy than what the outlook is for the U.S. economy in 2009,” Carney told reporters in Toronto following a speech.

In the bank’s statement last week it mentioned the risk of a “marked and prolonged” U.S. slowdown. “Of those two adjectives, ‘prolonged’ is probably the most important,” Carney said on Thursday.

In his speech to the Toronto Board of Trade on the turbulence in world financial markets, Carney said “the end is not yet in sight.”

That led some economists to expect a more prolonged round of rate cuts in Canada, after the bank reduced its overnight rate by a full percentage point since December to 3.5 percent.

“The fact that he characterized the credit turmoil as ongoing suggests that the BoC may remain on an easing path to buoy markets at this delicate time,” said Charmaine Buskas, economics strategist at TD Securities.

HOW TO ACT

Carney said the faulty practices that allowed the troubles in the U.S. subprime mortgage market to spread to markets throughout the world are now better understood. Therefore, policy makers have a better understanding of how to act.

In trying to repair stressed money markets, global policymakers should focus on addressing the three main problems that caused the disruption -- lack of liquidity, lack of transparency of structured credit products and misaligned incentives that encouraged excessive risk-taking.

However, he said officials can afford to take some time before taking additional action because “many of the market practices that contributed to the dislocations have stopped.”

He warned against overly prescriptive solutions from authorities, saying market participants have many reasons to improve their own standards.

“That said, recent events have revealed serious and widespread shortcomings that, if not addressed promptly, completely and credibly, will demand a more activist response on the part of regulators,” he said.

Carney said the central bank’s injections of cash into money markets have succeeded in bringing the key overnight interest rate close to its target, which now stands at 3.5 percent. Conditions in term money markets have improved since December but are still not back to historical norms.

“Canada is not isolated from global events,” he said. “Some of our institutions have suffered losses, and our economy is beginning to feel the effects of the deterioration in global financial conditions,” he added.

Reporting by John McCrank; Writing by Louise Egan; Editing by Renato Andrade

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