February 20, 2008 / 12:11 AM / in 10 years

Bank of Canada's Carney ponders degree of rate cut

VANCOUVER (Reuters) - The Bank of Canada has to weigh strong domestic demand against the spillover effects of the slowing U.S. economy when deciding how much to cut interest rates next month, Governor Mark Carney said on Monday.

<p>Bank of Canada governor Mark Carney is shown in this file photo taken on Parliament Hill in Ottawa January 31, 2008. The Bank of Canada has to weigh strong domestic demand against the spillover effects of the slowing U.S. economy when deciding how much to cut interest rates next month, Carney said on Monday. REUTERS/Chris Wattie</p>

Carney used his first speech since becoming central bank chief on February 1 to convey that he is keeping his options open, suggesting he could potentially reduce the bank’s overnight rate by 50 basis points, as most market players expect.

Carney’s first rate decision on March 4 comes after back-to-back cuts in December and January of 25 basis points each, leaving the benchmark rate at 4 percent.

In late January, the bank said more monetary stimulus would likely be required in the near term and Carney’s predecessor, David Dodge, said the bank preferred “measured” cuts, a term that Carney has stayed away from.

“The timing and degree of that stimulus will be determined at future fixed announcement dates, after we have conducted a thorough analysis of, and applied our judgment to, all information available to us at that time,” Carney said in his speech, echoing statements made earlier this month in Tokyo.

The Bank of Canada has not cut rates by as much as a half-percentage point since shortly after the September 11, 2001 attacks in the United States.

Most primary securities dealers surveyed by Reuters expect the bank to cut rates to 3.50 percent in March.

Carney kept his cards close to his chest, declining to comment on data released in the past two weeks that have highlighted the contrast between sagging exports on the one hand, and a vibrant job market and housing sector on the other.

But the possibility of a current account deficit in Canada, for the first time in a decade, is not a worry, Carney said. He said it was part of a larger global rebalancing that would require the United States to boost savings and reduce its deficit while China lifts consumption.

Canada’s domestic strength also explains why the bank has not felt much pressure to match the more aggressive monetary easing of the U.S. Federal Reserve.

GLOBALIZATION A BOOST TO DEMAND

In his speech, Carney expounded at length on the boost to Canada’s terms of trade from globalization, which has propped up prices for the country’s top commodity exports while keeping import prices low.

“The impact from our terms of trade is one factor that could lead to stronger domestic demand growth than we had assumed. This is something that we at the Bank will continue to watch closely,” he said.

Demand from emerging markets like China will determine how Canada’s domestic spending evolves, he said.

In addition, the strong Canadian dollar has pressured some retail prices lower but there is a risk that the downward pressure on inflation could be greater and more prolonged than the bank had assumed, he said.

On the downside, Carney cited the tightening of credit conditions and the U.S. slowdown as threats to the economy that could turn out to be more significant than the bank had projected.

“The question is the degree of this tightening and how prolonged this difficulty will be and that is something that we will take into account when we make our decisions,” he later told reporters in a press conference.

Additional reporting by Nicole Mordant, David Ljunggren and Louise Egan; Writing by Louise Egan; Editing by Marguerita Choy

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