Recession to persist well into 2009 but bank governor warns of over-reaction

TORONTO - Canada is in a recession that will persist well into next year but will slowly start to emerge from the gloom toward the end of 2009 and pick up economic strength in 2010, Bank of Canada governor Mark Carney said Wednesday.

Still, no one should underestimate the severity of the economic crisis, Carney said, although he refused to speculate on whether the country is headed for a depression - usually defined as a sustained period of economic shrinkage of about 10 per cent or more.

"Next year will be a trying one for many Canadians," Carney said in a luncheon speech to a Bay Street business audience.

"Issues of financial stability that were once the obsession of a pessimistic few are now the daily concern of many."

Carney warned that significant risks remain, including possible over-reaction to the crisis.

If consumers stop spending in light of the downturn - an otherwise rational course of action - the slump will worsen, he said.

"Fear of a recession feeds a recession," he told the Women in Capital Markets gathering.

Similarly, he said, market pressure on banks to build up capital and restrict lending makes it harder for businesses to borrow, exacerbating the slowdown and increasing bank losses.

Unlike in other countries, Carney said credit in Canada is still growing, albeit slowly, and businesses should not be afraid of asking banks for money.

"This is a time when good investments are made; this is a time when good loans are made."

One of five risks the central bank has identified is that the slump could depress incomes to such an extent that many households have difficulty servicing their debts.

That in turn could trigger an increase in defaults, causing significant losses among Canada's banks.

Household credit growth continues to grow at a "surprisingly" fast pace that is of some concern, he said, adding household debt relative to income has risen to record levels.

But the central banker said Canadians are coping thanks to low interest rates that are keeping their debt load manageable.

Carney called it "premature" to talk about following the lead of the U.S. Federal Reserve, which has lowered its key interest rate to zero per cent.

The Bank of Canada has sliced its trendsetting interest rate by two-thirds in the past year from 4.5 per cent to 1.5 per cent.

Carney did say the failure of Canada's commercial banks to pass through all the rate cuts is a "complication" for his monetary policy.

He said the situation was not "entirely surprising" given the banks' own higher borrowing costs.

Carney also made several proposals for avoiding future credit crunches, including that the International Monetary Fund become the "early-warning system" of problems in financial markets.

He urged financial institutions to build up capital in good times and draw on it in bad - the opposite of what is now occurring as bankers become more risk-averse in a shrinking economy.

"In this way, capital requirements would moderate the ups and downs of the credit cycle - the reverse of what currently happens - reducing the risk of a future crisis."

Although the crisis is relatively muted in Canada, Carney noted Canadian policymakers have been forced to take bold action.

The central bank has injected $36 billion of additional liquidity into money markets, while the federal government has bought $75 billion in mortgages, in an effort to keep banks lending to business and individuals.

However, he refused to say what further fiscal measures the federal government should take to stimulate the economy, saying only that Finance Minister Jim Flaherty was working on his Jan. 27 budget.

Carney said the measures will eventually kick in but the recovery won't be quick.
"It will take time for confidence to return and for capital to flow again."

By Colin Perkel, The Canadian Press