Loonie down, Bank of Canada governor says low rates needed to head off deflation

TORONTO – The Canadian dollar closed lower Thursday after three days of advances as remarks by Bank of Canada governor Stephen Poloz made it clear that rate hikes are likely a long ways off.

The loonie lost 0.42 of a cent to 93.98 cents US as Poloz told a business audience in Montreal that he needs to keep interest rates at historically low levels.

That’s because low rates are needed to head off the risk of a deflationary trap that would have dire consequences for the Canadian economy.

In fact, it may take a couple of years before inflation returns to the central bank’s two per cent target, which he called sacrosanct.

Poloz’s speech suggested he might be cutting rates right now if he were not fearful of adding more fuel to an already overheated housing market and near record high levels of household debt.

His speech came after the bank released its Financial System Review earlier in the week in which the bank lowered its assessment of overall risk in the system.

There was also growing speculation that the U.S. Federal Reserve could move as early as next week to start cutting back on a key stimulus measure.

A solid retail report and a budget deal in the U.S. Congress raised speculation that the Fed is set to start tapering its US$85 billion of monthly bond purchases.

The U.S. Commerce Department said retail sales rose 0.7 per cent in November, the biggest gain in five months and a better showing than the 0.6 per cent rise that economists had expected. October’s figure was also revised higher to 0.6 per cent from 0.4 per cent.

The budget agreement restores about $63 billion in across-the-board automatic spending cuts and would help prevent another partial shutdown of the U.S. government. Analysts believe the prospect of a shutdown over budget wrangling, along with difficulties in extending the debt ceiling, helped persuade the Fed to postpone tapering in September.

The 16-day shutdown in October crimped economic growth and hurt consumer confidence.

The prospect of Fed tapering has hung over markets since May when outgoing Fed chairman Ben Bernanke first raised the prospect of cutting back on asset purchases, if economic conditions allowed.

That’s because those bond purchases have kept long-term rates low, persuaded investors to put their money in the stock market and supported a strong rally on many markets this year.

Fed tapering concerns also continued to punish bullion prices as February gold fell $32.30 to US$1,224.90 ounce.

Bullion prices have also been depressed amid low inflation in many countries and an improving global economy, falling about 25 per cent this year.

Elsewhere on commodity markets, January crude on the New York Mercantile Exchange gained six cents to US$97.50 a barrel.

March copper was unchanged at US$3.30 a pound.