May 7, 2010 / 1:54 AM / 10 years ago

Bank of Canada says beware of commodity boom

* BOC warns of inevitable bust in commodity cycle

* BOC to unveil new commodity price index

* Provides no guidance on interest rate policy

OTTAWA, May 6 (Reuters) - The Bank of Canada warned investors and governments on Thursday not to bank on a continuous rise in oil and other commodity prices, even though they could rise to unprecedented levels.

John Murray, deputy governor of the central bank, made no hints about the future of Canadian interest rates or monetary policy in his speech in Edmonton, Alberta. Alberta is home to the world’s second-largest crude oil reserve.

Murray said it was tempting to see a spectacular future for the oil industry and other commodity sectors based on rapidly growing demand from emerging economies like China and India.

“If these two economies continue to grow at annual rates of 8 to 10 percent ... their prospective demand for commodities could be enormous,” he said in the prepared text of his speech.

“Couple this with the fact that many of the world’s resources are nonrenewable or are in limited supply, and you have a recipe for something that’s surely breathtaking.”

Before the heavy losses in oil prices this week triggered by fears over the Greek debt crisis, oil prices had been steadily climbing since hitting a recessionary low of less than $33 a barrel in late 2008. They had more than doubled to $80 per barrel in early May.

Murray said he could not rule out the possibility that commodity prices would rise to unprecedented levels.

“But if history is any guide, continuous rapid upward movement in real prices - oil or otherwise - is unlikely, as is a large permanent increase in the real price level,” he said.

Canada’s economy is particularly vulnerable to these price cycles, as natural resources account for about 10 percent of its gross domestic product and 45 percent of exports.

The boom and bust cycles of the past have taught policy makers not to trust in high prices, but rather to seek ways to soften the blow when the inevitable decline comes.

Murray said those steps appear to have helped soften the economic impact of the latest dramatic cycle — a boom in 2006-08 followed by the biggest financial crisis since World War Two.

To help further, the Bank of Canada will release on Friday a new commodity price index (BCPI). “This new BCPI, which incorporates new methodology, will be more accurate, representative and flexible,” Murray said.

Murray gave no guidance on the central bank’s view on interest rates, which it has held at a record low of 0.25 percent since April 2009.

On April 20, the bank withdrew an explicit commitment to hold rates steady until the end of June, a move that Governor Mark Carney said constituted a tightening of monetary policy.

Most market players expect the bank to raise its benchmark lending rate on June 1, although that view is less unanimous than it was last week.

Yields on overnight index swaps, which trade based on expectations for the central bank’s key policy rate, suggest there is a 58.3 percent chance of a 25 basis point hike on June 1. That is down from over 90 percent early last week, possibly due to widespread jitters over Greek’s debt crisis and the risk of contagion. BOCWATCH (Reporting by Louise Egan; editing by Peter Galloway)

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