Canada sees risks, but no world economic meltdown

By David Ljunggren and Randall Palmer | Reuters – 14 hours ago

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OTTAWA (Reuters) - Top Canadian economic policymakers see a raft of potential problems for a global economy they described as fragile yet still growing, but said they are ready to intervene to protect Canada from turmoil.

In testimony to a parliamentary committee on Friday, Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty both highlighted the risks posed by Europe's stubborn debt crisis and the slow U.S. recovery from recession.

But neither forecast a recession in either area, although Carney acknowledged Canada's economy might have contracted in the second quarter. Less than a month ago he had forecast 1.5 percent second quarter growth on an annualized basis.

"The considerable external headwinds that the bank has long identified are now blowing harder," said Carney, backing off previous language that suggested interest rates would be heading up in the short term.

Increasingly seen as a safe haven, Canada weathered the recession better than most nations. It was helped by a robust bank sector and more than a decade of budget surpluses, as well as by tax cuts introduced before world economies began to slow, and then by a package of government stimulus spending.

That package is now coming to an end, and Flaherty dismissed the idea that a revival of large-scale government spending would be a panacea.

"More spending now, in the current environment, that actually is the problem in Europe," he said. "Too much spending, accumulated deficits, it's exactly what we should not do if we want to maintain (our) fundamental fiscal health."

But if the world economy deteriorated dramatically, Canada would "do what was needed" to protect jobs and to shelter its own economy. "We would act in a pragmatic way as we have done successfully previously and recently," Flaherty said.

Flaherty -- who said the Conservative government would press ahead with its plan to eliminate the budget deficit by 2014-15 -- later told reporters Ottawa was not anticipating major external shocks.

RATE HIKE PUSHED OFF

In his testimony, Carney said the United States faced its weakest recovery since the Great Depression but that he felt the U.S. economy was going to grow at a reasonable pace.

Problems surrounding Europe's sovereign debt crisis have intensified, and that could continue to have an impact on jumpy global markets, he said.

Up to a month or so ago, when economies around the world started showing increasing signs of stress, most analysts had expected the Bank of Canada would raise interest rates later this year or early next, in line with its promise to keep inflation around its 2 percent target.

Carney said a hike depended on the state of the economy: "As the Canadian recovery has progressed, we have emphasized that we would be prudent with respect to the possible withdrawal of any degree of monetary stimulus."

Markets have actually priced in rate cuts but 10 of Canada's 12 primary dealers, who deal directly with the Bank of Canada, said in a Reuters poll they expect the next move to be up. They see nothing happening before December and most see no move until next year.

Canadian inflation has remained above the bank's 2 percent target for the last 10 months, although it eased to 2.7 percent in July, from 3.1 percent in June, matching market expectations.

FED RATE PLEDGE

Carney stressed rates were exceptionally low and warned Canadians not to take on too much debt.

David Madani, an economist at Capital Economics, said Canada clearly has a housing bubble, which is vulnerable to a sudden loss of investor confidence.

"We continue to expect prices to fall substantially over the next few years, which will have significantly negative implications for the broader economy," he said.

Carney said a promise by the U.S. Federal Reserve to keep rates low for another two years was positive for Canada in that it was providing additional stimulus to the U.S. economy in the form of steady rates all the way along the yield curve.

But he said Canada would not be constrained by U.S. interest rates, noting that Canadian rates have been as much two percentage points higher or lower than U.S. rates in the past.

It is rare for parliamentary committees to hear testimony of this nature during Parliament's summer break.

The opposition New Democratic Party called for the hearings as financial markets swooned, partly on fears that the world was heading back into recession.

"You cannot be rigid and inflexible," NDP finance critic Peggy Nash told Flaherty, saying she wanted more government investment in major infrastructure projects.