Financial News

Bank of Canada Governor Mark Carney warned Canadians on Monday of the risks inherent in what he predicted would be a prolonged period of low interest rates in advanced economies. At the same time, he said businesses and individuals should be aware that the era of cheap money would inevitably end. He also highlighted the relative strength of the Canadian economy versus that of the United States, and said it was appropriate for the two countries' monetary policies to diverge.

He described Canada as a country "caught in the middle" of the global crisis, warning that the country's banks, corporations and individuals should not be lulled into a false sense of security by current low borrowing costs.

"Low rates today do not necessarily mean low rates tomorrow ... Cheap money is not a long-term growth strategy," he said.  He said low costs could lead financial market players to underestimate risks when investing in debt instruments and could also lead some to seek riskier assets in search of high yields.  Likewise, corporations could be induced to roll-over bad debt instead of writing it off, simply delaying much needed adjustments, although Carney said there was not much of that behavior in Canada at the moment.

Finally, Canadian households are sinking deeper into debt, particularly with mortgages, and could be in trouble if their financial situations were to worsen suddenly.  He said a "wrenching adjustment" was already underway in the global economy with some countries accumulating excessive reserves and managing their currencies artificially.  This could even push some central banks into further quantitative easing, he said.

He gave little guidance on the Bank of Canada's interest rate intentions, and markets remain divided on when the next hike will be.  The bank held its benchmark rate steady at 1 percent last week for the second straight time, after hiking rates three times earlier this year. It cited European debt concerns and weak exports as potential drags on growth.

Carney repeated on Monday that any further interest rate hikes in Canada would require careful consideration, but he also took pains to distance Canada's situation from that of its giant neighbour.  "While the Canadian economy is importantly affected by developments in its largest trading partner, Canadian monetary policy is set for overall Canadian conditions and is guided by our 2-percent inflation target," Carney said in the prepared text of a speech he was giving in Toronto.  "It is entirely appropriate that our monetary policies have diverged somewhat."

Analysts in a Reuters poll this month predicted the first rate hike of 2011 would be in May, according to the median forecast. But Canada's 12 primary dealers were more dovish on average, taking the view that the move would not come until July. 

Markets saw a slightly increased probability the bank would keep rates on hold on January 18 after Carney's speech, according to yields on overnight index swaps, which trade based on expectations of the policy rate. The Reuters calculation of that trade suggested an 88.7-percent chance of rates staying on hold next month, up from 86.9 percent before the speech.