Governor of the Bank of Canada Mark Carney says the central bank is committed to maintaining current interest rates through the first half of 2010, although he noted the challenge of resolving global imbalances stands in the way of convincing economic recovery.

Speaking to the International Economic Forum of the Americas Conference in Montreal on Thursday, Carney discussed the recovery and rebuilding of the global economy. He noted that, “It appears likely that the global economy is entering a period of lower potential growth.”

It will take time to work off past excesses and to rebuild globalization, he said. Moreover, the composition of global growth will also shift, as the bank expects the U.S. recovery to be relatively mild, and emerging markets to play a bigger role. “The greater proportion of emerging-market growth in the overall growth of the global economy should create new opportunities, particularly by supporting commodity prices,” he said.

However, Carney cautioned that it’s not certain that emerging market demand will simply pick up the slack for the developed world, and he said that the resolution of global imbalances remains an important risk to the outlook for growth and inflation in Canada.

“As we noted in our policy decision last week, the recent sharp increase in the value of the Canadian dollar, if it proves persistent, could fully offset recent positive developments in financial conditions, commodity prices, and confidence,” he said. Nevertheless, he reiterated that the bank expects the policy rate to remain at its current level until mid-2010.

He also stressed that policymakers must continue to try and restore market confidence, although that too remains a work in progress. “With U.S. banks now raising significant capital to cushion their losses, the negative feedback loop between the financial and real economies has been slowed, though not yet reversed,” he said. “More capital will be required globally; the toxic assets in core banks still need to be addressed; and a host of vital financial markets, such as private-label securitization, must be relaunched. As a result, stabilization of the global financial system remains a precondition for a sustainable recovery, both globally and in Canada.”

Worldwide inventory and labour adjustments are ongoing, Carney noted, but he suggested that uncertainty over the employment outlook will weigh on consumption in most major economies for some time. “Declining investment and stagnant consumption will mean that private demand, excluding that generated by tax stimulus, will remain weak until the middle of 2010,” he said.

Absent sustainable private demand, governments have tried to take up the slack with fiscal policy responses, he noted. The success of this strategy depends on three interrelated factors, Carney said: the scale of the private savings response; the magnitude, duration, and credibility of the fiscal response itself; and the eventual rebalancing of risk between the public and private sectors.

“One of the biggest imponderables is the outlook for household savings rates,” Carney said, adding that this will depend on multiple factors, including wealth effects, risk aversion, the evolution of the financial system, and crucially, the credibility of fiscal policy itself.

To maintain that credibility, governments must have realistic strategies for allowing private risk taking to reemerge, he said. And, to rebuild market confidence, Carney suggested that transparency needs to increase so that risk can be priced more efficiently; core funding markets should be made more resilient and more efficient (through steps such as introducing clearing houses, standardizing products, implementing through-the-cycle margining, he said the Bank is also considering whether to support continuous private liquidity creation); macroprudential regulations must be enacted to help smooth the credit cycle; and, all countries must accept their responsibilities for promoting an open, flexible, and resilient international monetary system.

“Without credible policy frameworks and robust market infrastructure, private risk taking may not return to the extent required. However, there is every reason that Canada should be among the first to implement the agenda that I have described today. Through such leadership, we can do our part to create a more responsible, resilient globalization,” he concluded.

IE