Economists warn of deflation threat
HEATHER SCOFFIELD Globe and Mail Update
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.
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