Bank of Canada chief-"A lot" of headwinds hitting economy

Wed Oct 31, 2012 5:06pm EDT

* Central bank has signaled rate hike not imminent

* Warns that bond markets can also influence mortgage rates

* Says Canada's financial sector not too big

By Randall Palmer

OTTAWA, Oct 31 (Reuters) - Bank of Canada Governor Mark Carney, on the heels of telling markets that an interest rate hike was not imminent, offered several reasons on Wednesday for why the central bank has kept rates exceptionally low.

"There are a lot of headwinds against the Canadian economy from the rest of the world, there's a challenge to encourage business to invest, there are pressures on the currency," Carney told a parliamentary committee.

"There are a variety of reasons why it's advantageous to have very accommodative monetary policy and that's what we have here in Canada, very accommodative monetary policy."

The Bank of Canada is the only central bank in the Group of Seven leading industrialized nations which has hinted at raising interest rates. But Carney has effectively cautioned that it will be some time before it withdraws monetary stimulus.

That message was reinforced on Wednesday by data showing the Canadian economy shrank in August for the first time in six months, an unexpected contraction that pointed to a sharp slowdown in third-quarter growth.

HOUSING MARKET, DEBT GROWTH COOLING

Carney, who was testifying to the Senate banking committee following the release of the bank's quarterly Monetary Policy Report, was asked what could be done to contain what has been a hot housing market and high household debt levels.

He repeated his line that moving rates higher should be the last line of defense, though he said that ideally monetary policy should be complementary to other government measures.

Carney said condominium markets remained hot while other parts of the housing sector were adjusting to government measures to tighten mortgage insurance rules.

He warned that even if the central bank does not raise its main policy rate, individuals face the risk of higher mortgages rates because of what happens to the bond market.

"There are scenarios where there could be an increase over time in government bond rates, not because of monetary policy but because of just the sheer level of borrowing and uncertainty that develop on a global scale about the sustainability, so a credit premium coming into those bonds, and so that would also affect mortgage rates as well over time," he said.

Carney is also chairman of the international Financial Stability Board, and he addressed the issue of banks being considered too big to fail.

"There are two broader issues for a country like Canada that need to be considered. The first is relative size of the financial sector versus the economy as a whole ... We don't think this is the case in Canada but there were other economies in the world where the size of their financial sector was multiples of their GDP," he said.

"Every economy has to think about this question of ending too big to fail, and ending the perception of too big to fail and ... ending too big to fail is central to the agenda of the Financial Stability Board and by extension to Canada as a whole."

Carney said he did not believe there should be a specific cap on the size of banks in Canada, as there is in some other countries. But he said there was an effective limit on concentration and size, with the ultimate responsibility held by the finance minister.

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