February 4, 2010 / 7:11 PM / in 8 years

Bank of Canada sees economic thaw, warns of risks

WINNIPEG, Manitoba (Reuters) - The Canadian economy is looking up and should recover its lost ground this year, well ahead of Japan and Europe, though possible storms lie ahead, Bank of Canada Governor Mark Carney said on Thursday.

<p>Bank of Canada Governor Mark Carney speaks to the media in Toronto December 16, 2009. REUTERS/Mark Blinch</p>

“My message is relatively straightforward: the thaw is coming,” he said. “The recovery has begun. After a brutal economic winter, spring is within sight.”

The optimistic signs in his speech were enough for Scotia Capital to suggest he was carving an independent exit strategy, possibly hiking rates before some other advanced economies, though this was not a unanimous view.

“On net, we read this as a speech that reinforces the notion that the need for emergency levels of stimulus is over,” Scotia economists Derek Holt and Karen Cordes wrote, suggesting hikes by the third quarter and quite possibly earlier.

The comments had limited market impact, with Canadian stocks and the currency tumbling on fears about debt-laden European economies.

Carney said Canada’s labor market appeared to have stopped bleeding, businesses expect to make modest fixed investments this year, the private sector should be the sole contributor to Canada’s domestic demand growth next year and real output should reach pre-crisis levels by the third quarter of 2010.

By contrast, it will be 1-1/2 years before Europe and Japan reach their pre-crisis levels, he said.

The central bank has promised to keep interest rates at rock bottom through the middle of this year, assuming inflation remains tame. In a subsequent news conference Carney said current monetary policy was still appropriate.

However, while he said he did not think there was a housing bubble, he also cautioned Canadian households against borrowing too much since interest rates will at some point have to rise.

He also warned a sustained global recovery could be jeopardized unless there was major fiscal consolidation in the United States and elsewhere, higher U.S. household savings, policy-induced domestic demand in China and other nations, and higher exchange rates in countries with big surpluses.

“Should these conditions fail to materialize over the medium term, two equally troubling paths for the global economy are possible,” Carney said.

There would be a return to unsustainable current account imbalances, which would build financial imbalances again, he said, or there would be years of fiscal contraction and sluggishness that could lead to deficient demand and sharp global disinflationary pressures.

Speaking before this weekend’s meeting in Canada of the Group of Seven leading industrialized nations, he said it was important that all countries lay out credible paths back to fiscal sustainability in the not-too-distant future.

Though Canada’s economy is in many ways in better shape than its advanced competitors, he qualified its productivity performance in the past decade as abysmal, and tepid future productivity could mean the economy’s rate of potential growth is closer to 2 percent than the usual 3 percent.

The performance of the labor market and productivity growth will be important influences on monetary policy, Carney said.

BMO Capital Markets senior economist Michael Gregory read his comments on the implications of productivity as hawkish but balanced by dovish comments on the challenges Canada’s corporate sector is having in making needed adjustments.

Writing by Randall Palmer; editing by Jeffrey Hodgson

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