Economists await Carney’s words

OTTAWA — Bank of Canada governor Mark Carney has a lot of explaining to do this week.

OTTAWA — Bank of Canada governor Mark Carney has a lot of explaining to do this week.

With the central bank due to issue the scheduled interest rate announcement Tuesday and the quarterly Monetary Policy report on Thursday, economists and investors are awaiting what Carney has to say about what looks like an economy on a razor’s edge between recession and recovery.

Tuesday’s headline decision on interest rates is a no brainer.

As the central bank announced in April, the policy rate is to stay at the practical 0.25 per cent floor until at least next spring barring any nasty surprises. That means borrowing costs tied to the central bank rate and the banks’ prime rate — many types of mortgages, lines of credit, as well as consumer and car loans — will remain stable for at least another year.

But the question is what will Carney say about the economy, for the rest of this year and going forward?

And will Carney begin hinting about exit strategies from some of the extraordinary measures the bank and the federal government have introduced to keep the money markets functioning during the crisis?

When he last pronounced on the economy in April, Carney got one thing wrong and, according to C.D. Howe Institute chief executive Bill Robson, one thing spectacularly right.

Carney’s call for the economy to shrink by three per cent this year will almost certainly be revised because it was based on the first quarter coming in at negative 7.3 per cent, instead of the 5.4 per cent Statistics Canada later reported.

The consensus is now for the shrinkage to be held at 2.3 per cent, a significant difference in a $1.5 trillion economy.

What will be intriguing is what Carney says about output during the current third quarter, said economist Douglas Porter of BMO Capital Markets.

The last bank estimate was for a one per cent contraction, “but it’s pretty close call if it will show positive growth,” Porter said.

“There are even some people who are looking for strong growth in the third quarter,” he added, which would mean the recession is effectively over.

In April, Carney also unveiled the bank’s options for intervening in financial markets through so-called quantitative and credit easing — the short-term purchase of government and corporate bonds to pump cash into the economy and ease the credit crunch for consumers and businesses.

“It was a masterful explanation of what might happen because it explained it clearly, but also because it dampened expectations of the bank actually doing it,” said Robson.

“At the time there was some disappointment the bank wasn’t signalling a more aggressive stance, but I think it was appropriately measured. Canada’s response to this crisis has consistently been energetic as it was appropriate, but far more measured than what we’ve seen in other places.”

Carney, of course, wasn’t faced with the total meltdown of financial markets as his counterpart Ben Bernanke had to deal with in the United States.

But economists point out that the Bank of Canada governor did manage to introduce quantitative-easing light with the decision to maintain $3 billion in settlement balances to assure markets that there will be an available store of money to keep cash circulating in the economy.

And he helped restore stability in Canada with a precedent-setting commitment, albeit conditional, to keep rates at a specified level for one year.

Financial conditions have improved since April, but this is no time to be talking about exit strategies from low rates, argues CIBC chief economist Avery Shenfeld, because any hint interest rates could rise would add uplift to the already high-flying loonie.

In fact, Shenfeld said Carney may want to again warn as he did in early June about an overly inflated loonie representing a danger to the economy, a tactic that may have dampened speculation in the currency last month.

“A shot across the bow of these speculators, with perhaps a clear hint that the bank could intervene against them if need be, could help cool their ardour for the Canadian dollar,” Shenfeld said. He noted that both Australia and Switzerland intervened recently to halt upward pressure in their currencies.

If exit strategies are hinted at, Robson believes it will not be the low interest rate “guarantee,” but more subtle measures, such as the central bank’s purchase and resale agreements by which it injects extra cash into money markets.

Recent offerings of the bank’s term PRAs, as they are called, and of Ottawa’s mortgage asset swaps show a diminishing appetite for the financial vehicles, an indication credit conditions are becoming closer to normal.

“Exit strategies aren’t the high profile measures here they are in the U.S., where the Fed has extended itself further, but there’s a lot of importance to conveying to people that we are getting back to normal,” Robson explained.

The bank governor has taken some grief in the past over what many believed was an overly optimistic view about the Canadian economy’s ability to recover. Now with conditions materially improving, Robson believes he has some reason to crow — in cryptic bank speak, of course.

“I think when we look back on Mark Carney’s optimistic forecast, it’s going to look more sensible than people thought at the time,” he said.