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Recovery faces risks from abroad; interest rate direction in question: Carney

Canada's strong recovery is increasingly being put at risk from mounting debt problems confronting most of the industrialized world, Bank of Canada governor Mark Carney warns.

Canada's strong recovery is increasingly being put at risk from mounting debt problems confronting most of the industrialized world, Bank of Canada governor Mark Carney warns.

In a speech and news conference in Charlottetown on Wednesday, Carney lauded Canada's domestic economy, which he said would lead the Group of Seven big, industrialized nations in the next two years.

But the growing debt burdens in many advanced countries — and the need for governments to embrace a new "age of austerity" in spending — could restrain growth by wiping out $7 trillion from the global economy, absent countervailing measures.

"(The Canadian) outlook is subject to considerable uncertainties," he said. "Recent tensions in Europe are likely to result in higher borrowing costs and more rapid tightening of fiscal policy in advanced economies. Without countervailing policies, this could lead to a more protracted recovery."

The immediate impact on Canada, added Carney, is that even he is uncertain how to proceed with interest rates in the upcoming months.

After breaking new ground by hiking rates a quarter point two weeks ago, he cautioned that markets should not assume future increases are "pre-ordained."

"Given the ongoing uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global developments," he said.

Economists reacted with a shrug to the new advisory on rates, saying the central bank had broken little new ground. Analysts who thought the bank was on track for another quarter-point hike on July 20 before the speech remained in that camp afterwards.

"Mr. Carney provided no further clarity," said Michael Gregory of the Bank of Montreal. "We still judge that they will hike rates 25 basis points given domestic demand momentum."

Markets also saw the speech as a saw-off. The Canadian dollar rose slightly, then retreated, ending the day about where it began at 97.52 cents US.

In a news conference after his address, Carney stressed that the biggest risks facing Canada "are from abroad."

The domestic economy has been bouncing back from recession robustly with a 6.1 per cent advance in the first quarter of 2009, although the pace of growth will moderate.

Household spending, which has sustained the recovery, will slow to the pace of income growth. There was evidence the forecast is already becoming a reality with a report Wednesday that seasonally adjusted house sales fell 9.5 per cent in May.

But Carney says Canada's fundamentals remain strong — low government debt, sound banks, and healthy corporate and household finances.

While this will stand the country in good stead in withstanding the challenges ahead, he made clear Canada is not an island and that repairing the damage from the recent recession will be difficult and take time.

"This was the Great Recession," he said. "To claim otherwise with simplistic comparisons to prior downturns is to ignore both the rapidity and scale of the policy response, as well as the likelihood that the aftershocks from the crisis will persist for years."

The aftermath includes a world awash in sovereign debt, he said, calling Greece the canary in the coal mine of what other countries may soon face.

But the problem, while large, is not beyond remedy.

"It's not intractable. It's addressable, but it will take bold action," he said.

With world leaders meeting in two weeks in Toronto at the G20, Carney said governments must address the gaping holes in the financial system, such as ensuring banks have sufficient capital reserves and are discouraged from foolish risk taking.

Governments must also put in place plans to get out of debt and address fiscal imbalances by making sure countries such as the U.S. export more, and China imports more.

Carney also said Canadian corporations must be bold in meeting the challenges of the new economy where two-thirds of growth now resides in emerging economies, not established ones like the U.S.

Returning to a theme he has voiced in the past, Carney hectored corporate leaders for not investing enough in new equipment to increase their productivity and for not looking beyond the U.S. for new markets.

 
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