HEATHER SCOFFIELD Globe and Mail Update (Sept 19, 2008)
OTTAWA — The global financial crisis is hampering growth and constraining credit to such an extent that it will drive down inflation
in Canada and prompt the Bank of Canada to start cutting rates soon, some economists say.
“The deepening of the global financial crisis and associated pressures on global growth and commodity prices are unambiguously
deflationary for Canada,” said David Wolf, chief economist at Merrill Lynch Canada. “As a result, we are accelerating our
expectations for Bank of Canada easing ahead.”
He expects central bank Governor Mark Carney will cut the bank's key interest rate by at least a quarter of a percentage point on Oct. 21,
the bank's next rate setting date.
And the central bank will follow up with more rate cuts, driving down the key interest rate to below 2 per cent by mid-2009, Mr. Wolf projects.
The key rate is now 3 per cent, and the bank has kept it at that level since April, following a series of aggressive rate cuts.
The financial crisis has prompted inter-bank lending to freeze, and credit to households and businesses to dwindle in many countries,
Mr. Wolf said. Without credit, economies can't grow, and that will hurt Canada's prospects.
“The availability of credit, especially in the U.S., but also in Canada and elsewhere, is shrinking,” he said.
“While the situation remains fluid and the ultimate fallout cannot be predicted with confidence, it seems clear that the de-leveraging process
already underway is accelerating, further squeezing the credit lifeblood of the economy from a trickle to a drip.”
Canadian banks have escaped the worst of the credit crisis, and money markets are not as gummed up here as they are elsewhere in the world.
But Canadian financial institutions still need to conduct financing on global markets. And spreads in short-term money markets are far wider
than normal – although not as wide as in the United States.
“Without action, the price of credit to Canadian households and businesses will rise; credit availability may be pressured as well,” Mr. Wolf warned.
The Bank of Canada has said it stands ready to inject liquidity into money markets if needed, but has not seen much need,
except for a $2.3-billion injection into overnight money markets on Monday. On Thursday morning, the Bank of Canada said
it was backing a $180-billion (U.S.) globally coordinated effort to swamp money markets with U.S. dollars,
but would not actually use its $10-billion facility for now.
Economists at Bank of Nova Scotia also warned Thursday about the deflationary effects of the credit crisis.
“If falling prices really get anchored in expectations, the economic consequences could well be very dire,” they said,
urging more action from policy makers than just liquidity injections.
Some economists argued that central banks are essentially printing money by injecting so much of it into the money supply recently – a move usually
considered inflationary.
“The economic risks of this operation arise only if the credit lines extended by the world's banking system – the newly printed money –
are not withdrawn promptly after the financial markets recover,” said Carl Weinberg, chief economist at High Frequency Economics.
“In that case, a surge of liquidity may well lead to an explosion of demand for financial assets.”
But he doubts that will happen, and besides, he argues that the $180-billion announcement on Thursday “is by far the best and the most important
measure the central banks could have taken.”
Similarly, Mr. Wolf said that the central banks' liquidity creation measures are meant to counter a broad deflationary force in the form of
contracting credit. And the liquidity measures are only partly offsetting the credit contraction. So the injections, in this case,
are not inflationary at all.
