POLITICS

U.S. stimulus exit to hit loonie, lift interest rates, but good for Canada: BoC

08/27/2013 05:46 EDT | Updated 10/27/2013 05:12 EDT
OTTAWA - The Bank of Canada's John Murray says the eventual removal of monetary stimulus in the U.S. will have a negative impact on the loonie and lead to higher interest rates, but will be ultimately good for Canada.

In a speech to a business audience in Kingston, Ont., the deputy governor issued the Canadian central bank's first substantive pronouncement on the so-called "tapering" policy being contemplated by the U.S. Federal Reserve, which would result in a slowdown of the $85-billion-a-month stimulus it is currently injecting into the economy.

The logical consequence will be to give upward momentum to interest rates and apply downward pressure on the loonie, Murray said, but like the extraordinary stimulus program, the tapering will be a net benefit to Canada.

A stronger U.S. economy, along with the weaker loonie, will more than compensate for the drag of interest rates by providing support for commodity prices and increased demand for Canadian exports, he explained.

"The improving underlying strength of the U.S. economy should more than compensate for the drag from higher interest rates. Stronger external demand, coupled with downward pressure on our currency and support for commodity prices from a global economic recovery, will provide the lift," he told the Canadian Association for Business Economics.

Notes of the address were released in Ottawa.

Murray cautioned, however, that the exit from stimulus might be bumpy.

Policy-makers were alarmed he said with the market reaction earlier this year when the Fed first began hinting it might begin tapering in the fall if conditions continued to improve.

Bond yields spiked and financial assets that benefit from the extraordinary asset purchases fell sharply, even though the announcement was anticipated and there was no suggestion of actually moving away from stimulus.

The alarm came because "it suddenly seemed that unwinding unconventional monetary policies might not be as straightforward and painless as many had thought or at least had hoped," he said.

Murray said when it comes time actually move, he remains hopeful the market reaction will be calmer, in part because the removal of stimulus will come when economies have achieved "escape velocity" and in part because authorities have learned the value of telegraphing their intentions before acting.

When the exit strategy is commenced, he said, it will be "one of the best-telegraphed events in monetary history."