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Cablegate: Canadian Monetary Policy:

VZCZCXRO5365
RR RUEHGA RUEHHA RUEHQU RUEHVC
DE RUEHOT #0151/01 0302144
ZNR UUUUU ZZH
R 302144Z JAN 08
FM AMEMBASSY OTTAWA
TO RUEHC/SECSTATE WASHDC 7224
INFO RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUCNCAN/ALL CANADIAN POSTS COLLECTIVE

UNCLAS SECTION 01 OF 02 OTTAWA 000151

SIPDIS

SENSITIVE

SIPDIS

DEPT FOR WHA/CAN, EB/OMA AND INR

USDOC FOR 4310/MAC/ONA

TREASURY FOR IMI (FAIBISHENKO)

TREASURY PASS FEDERAL RESERVE

E.O. 12958: N/A
TAGS: ECON EFIN CA
SUBJECT: CANADIAN MONETARY POLICY:
NEW CENTRAL BANK GOVERNOR TAKES THE HELM IN ROUGH WEATHER

REF: (A) 07 OTTAWA 1991 (CANADIAN DOLLAR)

(B) 07 OTTAWA 1869 (CARNEY APPOINTMENT)
(C) 07 OTTAWA 0921 (HARPER GOVT AND BUSINESS)

SENSITIVE, BUT UNCLASSIFIED. NOT FOR DISTRIBUTION OUTSIDE USG
CHANNELS.

1. (U) SUMMARY/INTRODUCTION: Mark Carney begins a seven-year term
as Governor of the Bank of Canada on Friday, February 1 (ref B).
Carney, who gained his first degree at Harvard, is not a career
central banker. He worked for merchant bank Goldman Sachs in
various assignments for thirteen years prior to coming to Ottawa in
2003 for stints at the Bank of Canada and then the federal
Department of Finance.

2. (SBU) Carney succeeds David Dodge, a successful Governor who
oversaw a period of sustained strong growth and low inflation since
2001. The incoming Governor inherits a more dynamic economic scene.
This message lists some short- and long-term issues that confront
the Bank as Carney takes office. The issues involve facilitating
credit market operations, balancing inter-regional disparities in
growth and inflation, parrying pressures to stabilize the currency's
value (ref A), gauging and reacting to the impact of the U.S.
slowdown on Canada, and managing the Bank's relationship with the
Department of Finance (ref C) in a period when economic issues are
likely to be rising on the public agenda. END SUMMARY/INTRODUCTION

3. (U) BIOGRAPHICAL NOTE: Mark Carney received a bachelor's degree
in economics from Harvard University in 1988. He then received a
master's degree in economics in 1993, and a doctorate in economics
in 1995, both from Oxford University. Carney had a thirteen-year
career with Goldman Sachs in its London, Tokyo, New York and Toronto
offices. He was subsequently one of several Deputy Governors of the
Bank of Canada for fifteen months from August 2003 until his
appointment as Senior Associate Deputy Minister of Finance in
November 2004. In addition to his domestic responsibilities in the
Department of Finance, Carney also served as Canada's Finance Deputy
at the G-7, G-20, and the Financial Stability Forum. He has been a
good Embassy contact.

4. (U) ECONOMIC BACKDROP: Since significantly opening up their
trade and investment policies (mid 1980s-mid 1990s) while
simultaneously waging a tough fight against inflation (late
1980s-early 1990s) and later controlling escalating government
deficits and debt (mid-late 1990s), Canadians have enjoyed healthy
growth and employment with moderate inflation. Real annual GDP
growth has averaged around three percent over the past decade,
unemployment has fallen to lows not seen since the early 1970s, and
inflation - which is the central bank's main focus - has remained
within the target band of 1 to 3 percent.

5. (U) Since 2002, surges in commodity prices and in Canada's trade
with Asia have tilted growth and job creation toward resource-rich
western provinces, contributed to a steep appreciation of the
Canadian dollar against the U.S. dollar (by 50-60 percent over five
years), and sparked talk that Canada's economy might be "decoupling"
from the United States. Turbulence in U.S. credit and housing
markets since mid-2007 has had a relatively limited impact in
Canada due to the separateness of the two countries' banking systems
and because Canadian housing prices rose much less steeply than in
the United States. Still, Canadian credit markets have tightened
Qthe United States. Still, Canadian credit markets have tightened
recently, and the January 2008 equity market correction was felt
about equally in both countries.


6. (SBU) CARNEY'S CHALLENGES: Following are overviews of some key
issues facing the new Governor as he takes up his post:

a. (SBU) CREDIT MARKETS: Canada's C$33 billion market for non-bank
asset-backed commercial paper (ABCP) was frozen in August on
agreement among the market players. Carney's arrival in the
Governor's chair coincides with the expiry (or rollover) on January
31 of the market standstill agreement that was brokered in the fall
by an investors committee, led by veteran lawyer-executive Purdy
Crawford. The committee is asking Canada's five major banks, as
well as foreign banks (including HSBC, Deutsche Bank, and Citibank)
who are major players in the Canadian ABCP market, to contribute to
a C$14 billion fund to underwrite liquidity needed to re-start
trading of ABCP. While little information is publicly available, it
is reasonable to think that behind the scenes, the Bank of Canada

OTTAWA 00000151 002 OF 002


(along with the federal bank regulator, the finance department and
others) may be involved in some arm-twisting of market participants
to persuade them to contribute and comply. The market restructuring
process is expected to go on for at least the first few months of
Carney's tenure.

b. (SBU) REGIONAL IMBALANCES: Arguments about inter-regional
economic (and political power) disparities are a large, perennial
feature of Canadian public life. The boom in demand for Canadian
energy, minerals, and wheat has produced tight labor markets and
inflationary pressures in much of western Canada, while slumps in
forest products and the auto industry (exacerbated by the currency
appreciation) are disproportionately hurting the eastern provinces,
particularly Ontario but also Quebec. Since federal monetary policy
cannot discriminate among such regions, policymakers face
conflicting pressures, with some industries demanding easier credit
and a softer currency, even as wages in some sectors/regions are
jumping at double-digit annual rates.


c. (SBU) CURRENCY TARGETING: The Bank of Canada's macroeconomic
mission is inflation control. The Canadian dollar trades freely and
the central bank's only avowed role in the exchange rate is to
ensure that market movements are orderly. Even so, the Bank
regularly comments on whether given exchange rates are "appropriate"
or "justified." Given the Canadian dollar's steep appreciation
since 2002, many business leaders have demanded action to restrain
the currency's climb - particularly in the fall of 2007 when the
Canadian dollar's value briefly touched US$1.10. These demands have
abated as the current rate, about US 1.00 ("dollar parity"), is
close to the Bank's US 98 cent projection, based on economic
fundamentals. Still, if significant, upward exchange rate
volatility returns during his tenure, Carney can expect to be
pressed to veer from his inflation-fighting mandate.

d. (SBU) GAUGING THE EFFECT OF AND REACTING TO THE U.S. SLOWDOWN:
The energy/commodities boom and trade with Asia have made Canada
marginally less reliant on U.S. growth, and Canadian housing markets
remain healthy. Still, about eighty percent of Canada's exports go
to the United States, and U.S. residents remain by far Canada's main
source of tourism and foreign investment. Two leading Canadian
industries, forest products and autos, have been hit hard by the
slowdown south of the border. Consequently, the top debate among
Canadian economists now is over just how strongly the country's
overall growth will respond to U.S. economic developments. Carney's
view of the answer bears directly on the Bank's coming interest rate
decisions, which follow in the wake of January's substantial
reductions by the U.S. Federal Reserve. The Bank last cut its key
interest rate by 25 basis points on January 22, the same day the Fed
slashed its benchmark rate by 75 basis points, creating a 50 basis
point divergence between the two rates. The gap grew to 100 basis
points on January 30 when the Fed delivered another 50 point cut.
The next scheduled review of rates by the Bank of Canada is March 4.


e. (SBU) GETTING ALONG WITH THE BOSS: The formal independence of
Canada's central bank from the government is among the weakest in
the G7 countries. The governing law requires the Governor to
consult regularly (normally weekly) with the Minister of Finance,
Qconsult regularly (normally weekly) with the Minister of Finance,
and the Minister has the authority to direct Bank policy "in the
event of a profound disagreement between the Bank and the
government." Such a situation would likely lead to the Governor's
resignation. While there are no signs of policy differences, the
Harper government's economic policies have a somewhat populist
flavor (ref C) - in some measure due to Finance Minister Jim
Flaherty - and the government has shown less than usual sensitivity
to the autonomy of supposedly "arm's length" decision-making
agencies. In a period of increased economic stress, one of the new
Governor's challenges will no doubt be to maintain respectful
relations with the Finance Department and to avoid becoming (or
letting the Bank become) a lightning rod for discontent with
economic policy.

WILKINS

© Scoop Media

 
 
 
 
 
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