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U.S. action to impact Canadian economy

OTTAWA - With Ottawa and the Bank of Canada spurning more stimulus, the economy may still get an indirect boost from emergency measures being launched south of the border this week.

OTTAWA - With Ottawa and the Bank of Canada spurning more stimulus, the economy may still get an indirect boost from emergency measures being launched south of the border this week.

The betting among markets and economists is that U.S. Federal Reserve chairman Ben Bernanke will launch a second round of quantitative easing Wednesday, bathing the country with between $500 billion and $2 trillion in cash.

The most likely scenario is that Bernanke will announce the purchase of between $500 billion and $1 trillion in treasury bills, in $100-billion-a-month instalments.

Called QE2, or QE-The Sequel, the expected followup to $1.4 trillion of monetary stimulus that ended in March is controversial because, unlike last year, the U.S. economy is no longer in free-fall.

And many say it might not work, or not well enough to be worth the risk.

But having hinted at the move for months, analysts say it may be more destructive to do nothing than to go ahead with what may be stimulus overkill.

"I think they have no choice now because the markets have backed them into a corner," said Scotiabank economist Derek Holt. "If they don't do something there's going to be a wicket disappointment priced into some of the trades."

Bernanke is hoping a fresh infusion of cash into the economy will bring down long-term interest rates, injecting new life into the economy by making borrowing for mortgages and corporate loans easier and less expensive.

The other benefit is that by printing more of it, the U.S. dollar will fall further in comparison to other currencies, hence boosting exports and domestic industries.

But analysts caution that it is far from clear that already tapped out households will be lured into taking on more debt just because rates are low — and Bernanke is risking igniting inflation or another housing bubble.

Although the Bank of Canada toyed with the concept of quantitative easing in 2009, it eventually settled for a year-long program of emergency-level interest rates.

The Fed has no more room to move on rates, however, since it is already at zero, and is left with printing money as a last resort to spur an economy hobbled both by super-low inflation and high unemployment.

Already speculation of Fed action has helped lower longer-term mortgage rates in Canada even as the Bank of Canada raised its overnight rate three times during the summer.

There is a downside for the Canadian economy. A weaker U.S. currency means a stronger Canadian dollar, something that adds pressure on already hard-pressed Canadian manufacturers and exporters.

"Overall, the cumulative moves the Fed has made have improved the performance of the U.S. economy which has improved the performance of the Canadian economy," said Brian Bethune, chief economist with IHS Global Insight.

The Fed moving further into the easing camp also likely ties the Bank of Canada's hands on future interest rate hikes for the short term, since governor Mark Carney would be concerned about sending the loonie into orbit.

The dollar rose 0.4 of a cent to 98.42 cents U.S. in Monday trading.

"It means the Bank of Canada will be on the sidelines for a quite a bit yet," said Douglas Porter of BMO Capital Markets.

But it's the long-term where the pay-off would be most profound if quantitative easing works, say economists. Canada would reap the benefits of a stable recovery to its largest trading partner.

Doubts proliferate, however, that quantitative easing, even a large dose north of $1 trillion, can jolt the U.S. into a new era of sustained and robust growth.

Some say for policy to have a maximum impact, the U.S. would require a second round of government stimulus spending, something likely not available to President Barack Obama should the Republicans, as expected, take control of the House after Tuesday's mid-terms.

Quantitative easing will likely result in only a 0.1 per 0.2 per cent boost to U.S. gross domestic product, expects Holt.

Still, the ship on quantitative easing has likely already set sail, says Porter. He said no one is asking the why question anymore, only how and how much.

Porter says anything less than $500 billion would likely disappoint and result in a pull-back in markets.

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