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OTTAWA — The outlook for the Canadian economy grew darker Tuesday.
Canada's main stock market plunged, the central bank warned of slowing growth and rising inflation, and a report showed that prices for existing homes are falling for the first time since 1999.
Buckling under the pressure of the biggest one-day dollar decline in the price of oil since 1991 and widespread worry about the health of U.S. and Canadian banks, the Toronto Stock Exchange's S&P/TSX composite index slumped almost 400 points to close at its lowest since the end of March.
These were just some of the headlines from a dark day for North American markets that featured three of the leading U.S. policy makers scrambling to contain a financial meltdown that risks destabilizing the world economy.
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“The shockwaves we saw today are significant and we haven't seen the end of it yet,” Sherry Cooper, chief economist at BMO Capital Markets, said Tuesday from Toronto. “It's about the financial crisis in the U.S., which has caused contagion worldwide.”
In the most visible sign of worry about the U.S. financial sector, hundreds of IndyMac Bancorp Inc. customers lined up in California as early as 4 a.m. Tuesday to withdraw their money from the Pasadena-based lender. Once one of the largest mortgage lenders in the United States, IndyMac was taken over by regulators Friday after a bank run in which customers withdrew $1.3-billion (U.S.) over 11 business days.
The U.S. problems are rooted in the housing industry, which is in its worst recession in a generation amid record foreclosures as people took on mortgages they couldn't afford.
Canada's booming housing market, fuelled by rising incomes rather than shady subprime loans, is starting to cool. The average price for an existing home put up for sale eased 0.4 per cent to $341,096 in June from a year earlier, the first decline since January of 1999, according to data released Tuesday by the Canadian Real Estate Association.
On a day filled with nasty surprises, some of mildest news was the Bank of Canada's decision to leave its benchmark lending rate unchanged. Governor Mark Carney had given plenty of hints about how he was leaning, and most economists had advised their clients to expect the official lending rate to remain at 3 per cent.
But the statement explaining the Bank of Canada's decision contained some hard realities.
Policy makers cut their forecast for economic growth in 2008 to 1 per cent, the weakest since 1992, citing “the protracted weakness in the U.S. economy” and “ongoing turbulence in global financial markets.”
At the same time, they predicted raging oil and food prices would cause overall consumer price inflation to surge past 4 per cent by early 2009, well past the central bank's limit of 3 per cent.
Canada's economic woes are rooted in the U.S., where Federal Reserve Board chairman Ben Bernanke told lawmakers in Washington that there are “significant downside risks to the outlook for growth” in the world's largest economy, and that “upside risks to the inflation outlook have intensified.”
A month ago, Mr. Bernanke's assessment was that the risk of an economic downturn had diminished. The shift reflects renewed turmoil in financial markets that forced President George W. Bush's administration and the Fed to mount a rescue of Fannie Mae and Freddie Mac, two companies that buy or finance almost half of the $12-trillion (US) of U.S. mortgages.
U.S. Treasury Secretary Henry Paulson, Mr. Bernanke and Securities and Exchange Commission chairman Christopher Cox appeared before the Senate banking committee to explain the administration's latest efforts to limit the fallout from the collapse of the subprime mortgage market a year ago.
Mr. Paulson is seeking congressional approval for a plan that would allow the Treasury to buy equity in two government-sponsored enterprises and extend each company a $2.25-billion line of credit. Mr. Paulson announced his proposal on Sunday after a week of trading that saw shares of both companies lose half their value.
The Treasury chief, who ran investment firm Goldman Sachs Group Inc. before joining the Bush administration in July of 2006, said his goal was to restore investors' confidence that the institutions won't fail.
“There is systemic risk and no one who has looked at this can say there isn't,” Mr. Paulson said. “The greater the confidence, the less likely the taxpayer will have to do anything.”
All the uncertainty was too much for stock investors.
The S&P/TSX composite index slumped 383.73 points, or 2.8 per cent, to 13,357.56, its lowest close since the end of March. The energy sector, which makes up one-third of the benchmark index, delivered the bulk of the damage, falling 3.7 per cent after a flurry of selling knocked more than $10 a barrel off the price of oil in New York Tuesday morning.
The sudden reversal of oil-fuelled concerns that the commodity's record-shattering rally – which has been a critical source of strength for the Canadian equity market this year – may finally be at its end.
A barrel of light, sweet crude ended the day $6.44 lower at $138.74 as traders bet that weak economic growth in the U.S. and elsewhere would limit demand for fuel.
Mr. Carney and his five deputies on the governing council also cut their estimate for economic growth for 2008 to 1 per cent, which would be the weakest in almost two decades, citing “protracted weakness” in the U.S. economy and “ongoing turbulence” in financial markets.
The central bank's decision to leave borrowing costs unchanged suggests Mr. Carney's biggest concern is keeping a lid on Canadian expectations about prices. Policy makers raise and lower interest rates to keep inflation advancing at an annual rate of 2 per cent and are uncomfortable with prices advancing any faster than 3 per cent.
Still, there were some glimmers of hope. The central bank said little has happened to change its longer-term growth outlook, and affirmed that it expects higher prices for exports, relatively low interest rates and a “gradual recovery” in the U.S. to spark a Canadian rebound starting early next year.
The slide in the price of crude, if sustained, could also help the economy by easing inflation, leaving policy makers more room to focus on stimulating growth.
With reports from Bloomberg News, Reuters, David Parkinson, Lori McLeod and Ramya Jegatheesan
