Bank of Canada warns on capital flows, prices

* Dynamics of prices, capital flows create major risks

* Asset bubbles could form if policies not right

By Louise Egan

CALGARY, Alberta, March 26 (Reuters) – Misguided policies
for dealing with high inflation and a flood of capital into
emerging markets could lead to financial instability and weak
economic growth, the Bank of Canada said on Saturday.

“The stakes are very high,” said Bank of Canada Governor
Mark Carney in a speech at the annual meeting of the
Inter-American Development Bank in Calgary.

“The current dynamics of commodity prices and capital flows
create major risks to financial stability and sustainable
growth across our region,” he said.

Carney said some countries were postponing interest rate
hikes, needed to arrest inflation, for fear of further boosting
currencies that have already been pushed higher due to heavy
capital inflows.

As the world recovers from recession, nations have clashed
over foreign exchange policy as many countries adjust to
ultra-low U.S. interest rates and China’s reluctance to let the
yuan appreciate more freely. Investors seeking high yields have
sunk their money into Latin America, exacerbating these
tensions.

Referring to what Brazil’s finance minister dubbed the
“currency wars,” Carney said that when large economies keep
their currencies from appreciating, others feel pressured to
follow suit. This leads to a chain reaction of other
distortional policies.

“The collective impact of this behavior risks inflation and
asset bubbles in emerging economies and, over time, subpar
global growth,” he said.

Carney sees the current high commodity prices persisting
for much longer than in past boom cycles because of the rapid
urbanization and mushrooming middle classes in emerging
economies such as China and India.

“Even though history teaches that all booms are finite,
this one could go on for some time,” he said.

The other thing that is different about this commodity boom
— and which could lead to dangerous global imbalances — is
that the strong demand from emerging markets is combined with
tepid growth in core advanced economies such as the United
States.

This shift to a “multipolar economy” is permanent and
should not be underestimated, Carney said.

“Some countries are postponing monetary tightening in the
hope that old relationships reassert.” Others have introduced
measures to curb capital inflows. “All appear to be
underestimating the scale of what is happening. Therein lies
the risk of another crisis,” he said.

Carney said Latin America is the region most affected by
these pressures. However, he too has grappled with a sharp
currency appreciation in Canada that has hampered the country’s
recovery and allowed him to keep benchmark interest rates on
hold since last September. Foreign investors also bought a
record amount in Canadian securities last year.

In terms of measures that can be taken in the short term to
contain these pressures, Carney proposed a renewed commitment
among G7 countries for floating exchange rates and a global
code of conduct on capital flows.
(Reporting by Louise Egan; editing by Peter Galloway)

Bank of Canada warns on capital flows, prices