Why Fed tapering will be good for Canada

National Post Louise Egan, Reuters | 13/08/27

KINGSTON, Ontario — Eventual removal by the U.S. Federal Reserve of its massive stimulus program should be seen positively, Bank of Canada Deputy Governor John Murray said on Tuesday, responding to critics who say it will cause damage around the world.

Whenever the Fed begins winding down its unconventional monetary policy it will be in the context of a strengthening U.S. economy, Murray said, and the benefits to the Canadian economy will outweigh any risks.

“The improving underlying strength of the U.S. economy should more than compensate for the drag from higher interest rates,” he said in a speech to economists. “Stronger external demand, coupled with downward pressure on our currency and support for commodity prices from a global economic recovery, will provide the lift.”

Murray said interest rates will normalize as the global economy grows, “but there’s no guarantee that this is going to be absolutely orderly or painless for everyone,” he said in answer to a question. “But at least it’s being done in the context of recovery.”

The Fed has said it plans to start reducing its US$85-billion-a-month purchases of U.S. Treasuries and mortgage-backed securities by yearend, with an eye toward drawing the program to a close by mid-2014. The purchases have been aimed at driving down long-term interest rates and have been credited with infusing liquidity that has benefited global financial markets.

The president of the Federal Reserve Bank of Atlanta, Dennis Lockhart, told Reuters on Saturday at the annual Jackson Hole policy retreat for the world’s central bankers that Fed tapering could begin in September, provided there is not “really worrisome” economic news between now and then.

Concerns over Fed tapering have sparked an exodus of cash from emerging markets, including India and Brazil, whose currencies and stock markets have suffered steep losses in recent days.

“Before getting too excited about the negative consequences of exiting, it is important to step back and consider why events might unfold in a manner that is more benign than some critics have feared,” Murray declared.

He said the exit from what has been extraordinary policy accommodation will take place only when officials see there are clear and convincing signs the U.S. economy and, subsequently, others, have achieved self-sustaining momentum.

In addition, monetary authorities have learned the value of clear communication and not all advanced economies will exit at the same time, Murray added.


His remarks about the downward pressure on Canada’s currency that would accompany a Fed exit and a U.S. recovery underlined how the Bank of Canada has stopped referring to “the persistent strength of the Canadian dollar” as one of the challenges facing the economy.

He said that over the past five years the Fed stimulus measures have put upward pressure on Canada’s dollar, but that this had been more than offset by greater U.S. demand for Canadian exports, and higher asset and commodity prices.

“In other words, Fed easing was a net positive for Canada, making a difficult situation better,” he said. “The process will work in reverse once the exit begins, but with one important difference: it will take place in the context of a strengthening U.S. economy.”

The Canadian dollar strengthened to 94.07 Canadian cents to the U.S. dollar in late July 2011 – its strongest since November 2007 – in part due to Fed easing. It has weakened steadily in recent months in anticipation of Fed tapering, and stood at $1.0477 to the greenback at 4:14 p.m. EDT (2014 GMT).


An economist in the audience asked Murray whether the Bank of Canada might again provide markets with forward guidance on its policy course as it did in 2009, and which is a strategy being used by the Fed and the Bank of England, specifically whether it had thought about linking monetary policy to the unemployment rate.

The Bank of Canada supports forward guidance by others but does not see the need for it in Canada, Murray responded. “We’re in a situation where we’re in a conventional monetary policy zone with a 1 percent overnight rate and we’re back to the norm.”

On whether the Bank of Canada plans to publish an interest rate forecast, he answered emphatically, “No.”

“There is a debate in the community about whether it comes with some costs … a false sense of commitment. (There is) a worry that it creates just a little too much certainty in the minds of some participants … you lose some of the independent thought and forecasting,” he said.

Market players surveyed by Reuters in July forecast the Canadian central bank would resume raising interest rates in the fourth quarter of 2014.



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