Canadian markets catch breath as credit panic wanes

TORONTO (Reuters) - Canadian financial markets won a fragile new lease of life on Wednesday after the Bank of Canada made it easier for banks to get cash and the firm at the center of a commercial paper maelstrom found some relief.

Toronto stocks climbed after four successive days of decline and the Canadian dollar tiptoed up from early morning three-month lows. By 11:15 a.m. the Canadian dollar was at C$1.0739 to the U.S. dollar, or 93.11 U.S. cents, above its three-month low of C$1.0796 to the U.S. dollar, or 92.62 U.S. cents.

Stock in Coventree Inc COF.TO, whose financing problems earlier this week brought the U.S. subprime mortgage meltdown thudding home to Canada, doubled in value after the investment firm said late on Tuesday that it had managed to place C$600 million ($561 million) in asset-backed commercial paper.

"I think things have calmed down a bit but people are still nervous," said John Kinsey, portfolio manager at Caldwell Securities. "I think people will be wary for some time... it's not over until it's over.

"It's prudent for investors, if you have a lot of cash, to put your toe in the water but you should stay pretty close to home."

Canada's C$112 billion market for commercial paper seized up on Monday after Coventree said it had been unable to place liquidity-backed paper and extendible paper.

Rating agency DBRS said 17 trusts had asked for additional liquidity.

But some liquidity providers balked, and said the market was not yet at the crisis point where extra cash is needed.

The Bank of Canada, responding to the market's fears, added a string of extra securities on Wednesday to those that it accepts as collateral for repurchase operations, and then pumped C$350 million into the market in a morning operation.

Its repo operations are designed to steer the overnight rate towards the central bank's 4.5 percent target. The London Interbank Overnight Rate, a guide to Canada's rates, hit a six-year high of 5.342 percent at the 11 a.m. fixing, well above the target rate.

Analysts welcomed the central bank's expanded list, which includes Canada mortgage bonds and provincial debt as well as some commercial paper and short-term municipal paper. It does not include the asset-backed commercial paper at the center of the storm.

"This is helpful and may alleviate some of the pressure. It may not be the end of the nervousness that we see, but it's a positive step in the right direction," said Mark Chandler, fixed income strategist at RBC Capital Markets.

"The bank's action today is to help liquidity in the system overall. I don't think they want to pick winners and losers among specific classes."

The government has insisted that Canada's economy and financial sectors remain sound.

"There are some stresses in some corners of the Canadian money markets, and we're not immune to fluctuations in global financial markets, including the U.S. subprime mortgages, but the Canadian fundamentals are strong," Finance Minister Jim Flaherty told Reuters on Tuesday.

J.P. Morgan analyst Ted Carmichael said financing delays could slow economic growth and put central bank interest rate hikes on hold indefinitely.

"As long as the commercial paper market remains seized up, the Bank of Canada is highly unlikely to raise the policy rate on the September 5 decision date," he wrote in a note to clients.

"Should the current market situation persist, or worsen, through August 24, the JPMorgan BoC rate forecast will be changed to 'on hold indefinitely'."

Until the recent turmoil in the commercial paper market most analysts had expected the Bank of Canada to raise interest rates on September 5 to cool the economy and keep inflation under control.

(Additional reporting by Nicole Mordant)