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ANALYSIS-Bank of Canada could surprise again--by not easing

Published 04/21/2009, 04:00 PM
Updated 04/21/2009, 04:08 PM
TGT
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By Louise Egan

OTTAWA, April 21 (Reuters) - Bank of Canada Governor Mark Carney reminded markets on Tuesday that he's not afraid to defy expectations, and those expecting unconventional methods to stimulate the economy should hedge their bets accordingly.

Carney went against the market's firm expectations of unchanged rates when the bank pushed its overnight rate to a historic low of 0.25 percent, down from 0.5 percent, and said it was prepared to keep it there for another full year.

Now the focus shifts to Thursday, when the central bank outlines how it might use unconventional moves like quantitative easing, or printing money to buy securities, if it feels the need to go further.

And while market consensus is that unorthodox stimulative methods will start this quarter, there are clues that the former Goldman Sachs banker turned central bank chief could foil their expectations again.

"If things were really, really bad right now, I think Mr. Carney, who has a lot of private sector experience, would have been in the game already," said Andrew Gretzinger, senior economic analyst at MFC Global Investment Management.

"Right now, they're probably better to sit back and see how things evolve."

In fact the bank's own language on Tuesday, and improvements in Canadian credit markets, raise the possibility that the new expanded toolkit may only ever exist on paper, and its statement suggested that one option is to do nothing.

It said that the cumulative rate cuts since December 2007, plus its vow to keep the benchmark rate at 0.25 percent until mid-2010 represent "the appropriate policy stance to move the economy back to full production capacity and to achieve the 2 percent inflation target."

That means the bank needs proof its outlook is wrong before embarking on additional easing.

The statement omitted any reference to further stimulus, whereas on March 3 it said it would "monitor carefully economic and financial developments in judging to what extent further monetary stimulus will be required ... ."

The March 3 statement also promised a framework for "credit and quantitative" easing on April 23, and market speculation has since run rampant over the timing and details of that strategy.

DEPLOYING THE NUCLEAR OPTION

Carney, an Oxford and Harvard trained economist, has been far more reluctant to deploy what one analyst calls "the nuclear option" than his counterparts at the U.S. Federal Reserve or Bank of England, in part because Canada's financial system ranked among the world's soundest.

The Fed vowed last month to pump an additional $1 trillion into the U.S. economy, partly by buying government bonds for the first time since the 1960s. The British, Swiss and Japanese central banks have made similar moves.

"There is not as clear cut a need to change the monetary regime as there is in the U.S. or the U.K.," said Stewart Hall, markets strategist at HSBC Canada, who nonetheless expects some form of additional easing later this year.

Canadian credit spreads have improved in recent weeks, another indication the nonconventional approach may not be employed anytime soon -- unless there is a shock.

"If the other shoe were to drop then the Bank of Canada would be in there sooner rather than later. But I wouldn't put a date on something like that. I don't think there's anything imminent," said Gretzinger.

Finance Minister Jim Flaherty, who meets frequently with Carney on policy matters, told reporters on Monday the Canadian bond market was "functioning well again and there are encouraging signs in capital markets."

Even if the bank opts to print money, it will likely be in small doses aimed at specific niches of the market, predicts Derek Holt, economist at Scotia Capital.

"There's just no large scale need for Fed-style initiatives in Canada because our credit creation channels are not as impeded," he said.

Carney has stunned markets in the past, most famously last June when he held rates steady despite unanimous market predictions of a cut. While his intentions may not become any clearer on Thursday, he may shed more light on the path forward when he finally lays all his cards on the table.

"Let's have a look at the details, look at the programs. From that we'll get a sense of the willingness of the Bank of Canada to employ those programs," said Hall. (Reporting by Louise Egan; Editing by Jeffrey Hodgson and Janet Guttsman)

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