BUSINESS
09/20/2011 04:00 EDT | Updated 11/19/2011 05:12 EST

Carney in position to do some good in boosting sagging confidence: analysts

SAINT JOHN, N.B. - Bank of Canada governor Mark Carney is issuing a call to action to governments in advance of pivotal meetings this week, and laying partial blame on their ineffectual responses so far for taking the world to the precipice of a new recession.

In a hard-hitting speech to a business crowd in Saint John, N.B., Carney said Tuesday the combination of sovereign debt worries and bad politics have sapped investor confidence.

"The debt-ceiling fiasco in the United States and the inability, to date, of European policy-makers to get ahead of their crisis have reduced investor confidence in the effectiveness of policy," he said.

"The combination of high debt loads and unpredictable politics is toxic."

The no-nonsense language, unusual for a central banker, highlights the importance Carney gives to the upcoming meetings of the G20 finance ministers and International Monetary Fund later this week. But it also underscores the gravity of the situation as Carney sees it.

Europe's fiscal and debt problems are serious but fixable, but governments must act swiftly to fix them, he said.

And he said the U.S. is not doomed to suffer another recession, but the risks have clearly risen and squabbling politicians in Washington are only making matters worse.

While these problems — and solutions — lie mostly outside Canada's borders, Carney said that the Canadian economy will not skirt by another shock unscathed. In fact, the economy is already being damaged through a tightening of financial conditions and a slowdown in growth, particularly in the export sector.

"The risks to our economy remain largely external and are skewed to the downside," he said, foretelling a growth projection downgrade from the bank at its next policy meeting in October.

Earlier in the day, the IMF cut Canada's projected growth for this year to 2.1 per cent and 1.9 per cent in 2012, while also downgrading economic expectations for much of Europe and the U.S.

"I don't think anyone should be surprised on the direction of the adjustment given events globally," he told a news conference after his speech. "We have directionally said the same thing."

Carney says the world can, however, avert another economic shock if policy-makers act.

The most immediate concern is funding pressures building on European banks that hold billions of dollars in suspect sovereign debt.

"If not quickly reversed, this situation could create a damaging negative feedback loop among banks, lending and the real economy," he said, much as occurred in 2008.

The U.S., meanwhile, is in the midst of the weakest recovery since the Great Depression, taking it to the edge of another recession.

"The U.S. economy is close to stall speed, where a negative feedback loop between weak employment, consumer demand, and business hiring and investment could emerge," he warned. This could happen if markets plunge further, further slicing household wealth and confidence.

Carney urged European leaders to capitalize their banks, and also offer "a sizable funding backstop" for indebted European governments. This would give them time to restructure their eurozone.

Generally, he said world leaders must move to implement reforms they had already agreed to, including financial reform, rebalancing demand between export and import economies, and restructuring currencies to reflect their true market value.

Prime Minister Stephen Harper said his government intends to stick to its plans for economic recovery.

"Our anticipation at this point remains though fundamentally the same as it has been: which is that we will continue to recover, the global economy will continue recovering, the Canadian economy will continue to grow, but slowly," Harper said when questioned at the United Nations.

"Should the situation change we'll make appropriate modifications in our plan. But at the moment, we believe that the plan we have, which is focused on creating jobs and growth in the long term by making targeted investments and ensuring that we have a stable fiscal situation over time, that remains the focus of the government of Canada."

Michael Gregory, managing director and senior economist with BMO Capital Markets, said Carney's frustration was palpable.

"He is egging on everyone to do the right thing and more importantly do the right thing sooner rather than later."

But Gregory said while Canada is impacted by the Europe and the U.S. economies, the country should examine what it can do domestically.

"How do we look to diversify our exports? How do we cope with a Canadian dollar that's going to be relatively strong for probably a long period of time?" he said.

"At the end of the day, those issues probably matter more for Canadians than if Greece defaults."

If a new shock occurs, however, Carney said the Bank of Canada is ready and has the tools to help boost the Canadian economy. For instance, Carney suggests that he could keep interest rates lower for a longer period than normal circumstances would warrant to ensure lending markets remain active in Canada.

"Canadians can ... be assured that the bank will take the necessary steps to ensure that core financial markets remain liquid and operating," he said.