Flaherty sees hopeful signs

OTTAWA — Finance Minister Jim Flaherty says he sees some encouraging signs of recovery in the economy, but warns that unemployment will continue strike Canadians hard this year.

OTTAWA — Finance Minister Jim Flaherty says he sees some encouraging signs of recovery in the economy, but warns that unemployment will continue strike Canadians hard this year.

“I think we are seeing some small encouraging signs, signs of more confidence, an improvement in the bond markets, some improvement in capital markets, some more confidence overall in the economy,” he said Wednesday.

“But having said that, we are going to see significant unemployment, we are seeing significant unemployment. That’s one of the very regrettable things about employment losses is that they tend to sharply go off and then take a gradual return.”

Canada lost 357,000 jobs in the past five months and could lose over 600,000 jobs in total by the year’s end, forecasters say.

Meanwhile, the Bank of Canada, which on Tuesday cut short-term interest rates to the bone, is preparing to unveil options for dramatically increasing its already aggressive intervention into credit markets on Thursday.

The central bank has said little about what it plans to do, but set the stage for heading into uncharted waters Tuesday when it dramatically changed its view on the severity of the downturn.

After predicting in January output would decline by 1.2 per cent this year, the central bank now says the stumble will set the economy back by three per cent, almost triple as much. And the recovery will be delayed and more muted, it added.

On Wednesday, the International Monetary Fund offered a similar assessment. Canada’s economy will shrink by 2.5 per cent this year and only grow 1.2 per cent next, the think tank said, calling the world recession the “the most severe” since the Second World War.

Bank governor Mark Carney may have no choice but to move to so-called quantitative easing — printing more money to ease credit — since he has done all he can on traditional policy by taking the overnight rate to the lowest practical level of 0.25 per cent.

The bank’s announcement Tuesday that it will ensure $3 billion in reserves, giving chartered banks more leeway to lend, “is a pretty clear signal they’ll go quantitative easing tomorrow (Thursday),” said Derek Holt of Scotia Capital Markets.

“That’s signalling they are no longer going to be focused on sterilizing anything they do in the market.”

The options for the central bank range from very modest, to the kind of aggressive action already put in place in the United States, the United Kingdom and Japan, where wide swaths of assets were purchased by the central banks.

The bank’s options include printing new money to buy up Government of Canada bonds, or entering niche credit markets, such as the stalled asset-backed commercial paper, auto leasing and credit card receivables.

“The objective of doing that is to increase the liquidity in the market to not only get the short-term rate down, but some of the key medium and longer-term interest rates down as well,” explained TD Bank chief economist Don Drummond.

“If they buy corporate bonds, that could get corporate bond rates lower as well.”

Any measure in that direction would be entering into uncharted waters for the staid Bank of Canada. Such unorthodox measures are normally associated with developing nations, noted Holt, adding that the behaviour would likely solicit condemnation from the IMF.

But the establishment views of what is acceptable monetary policy have changed dramatically since the global economy and financial markets began unravelling last year.

“We’re dealing with the total collapse of money creation channels in the core banking system and the absolute collapse of the shadow banking system that had become so dominant in the past 20 years in the U.S., Europe and Japan,” Holt said.

“In that context, these very different policies are filling the void.”

In one sense, the central bank already moved into a mild form of quantitative easing with two measures introduced Tuesday.

Along with taking the overnight policy rate to 0.25 per cent, in essence zero, governor Carney announced the bank’s liquidity instrument — purchase and resale agreements — by which it pumps money into the chartered banks would be extended out to as much as a year.

And it increased its daily reserves from $25 million to as much as $3 billion in a nod to banks their short-term loans will be covered.

Even the central bank’s near-guarantee that it will keep the overnight rate at the floor of 0.25 per cent for a full year is designed to give lenders assurance to increase credit.

Bank of Montreal economist Michael Gregory says the central bank may follow up with similar modest measures, or take more unorthodox action if they perceive credit remains a major restraint on the economy.

“The best way to think of this is, what they want to do is keep lowering interests rates, but they can’t lower the overnight rate anymore, so they have to do other measures. They’ve done the easy stuff, now we’ll see the harder stuff, the stuff that needs a little more explaining down the road.”

But Carney doesn’t appear to be worried about inflation down the road. His current view is that inflation is heading south and won’t return to the desirable two-per-cent target until late 2011.

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