Bank of Canada: hedge funds positive for markets

Date: Wednesday, November 8, 2006
Author: Frank Pingue, Reuters.com

VAUGHAN, Ontario (Reuters) - Bank of Canada Deputy Governor David Longworth said on Wednesday that hedge funds have a largely positive impact on financial markets and any risks they might pose are under control for now.

"Hedge funds add to the depth and liquidity of Canadian financial markets," Longworth told the World Hedge Funds conference in the Toronto suburb of Vaughan.

"It's useful to note that the largely positive influence of hedge funds stems from their sophistication, their size, the diversity of their objectives and strategies, and the instruments they use," he said.

Hedge funds, lightly regulated investment pools used by wealthy investors, use leverage and complex trading strategies to chase high returns.

Longworth said the central bank's concerns about hedge funds focus on the potential for banks to become overexposed to them. If several large hedge funds suffer losses due to swings in market prices, banks could suffer credit losses, he said.

The second risk is that hedge funds implement investment strategies that aggravate market prices movements, leading to problems for other financial institutions.

NO CHANGE SETTING OVERNIGHT RATES

While Longworth did not offer an outlook for the Canadian economy or monetary policy, he did say the central bank has no plans to alter its inflation-targeting model because of the strong economic growth in Western Canada.

Answering questions after a speech to the hedge fund conference, Longworth said the bank focuses on national inflation. The bank targets inflation at the center of a 1 percent to 3 percent range.

Asked if the oil-driven strength in Western Canada had inspired the bank to alter those inflation targets, he said: "No, it has not led to us tinkering with the model, we still do target national inflation and to our first approximation, we're looking at the national output gap.

"That being said, in order to be able to do projections ahead in how the national economy is going to evolve, we have to look very carefully at what's happening in the regional markets."

Longworth also noted that decreased economic volatility in recent years had helped reduce volatility in fixed-income markets, but said it was unclear if that would continue.

"What is still unclear is whether we will see further declines in the volatility of rates on long-term bonds and of equity prices as markets adjust to the decline in macroeconomic volatility that we have already seen," he said.

A further slowing of global economic growth would likely result in increased uncertainty and financial market volatility, he said.

(Additional reporting by Louise Egan in Ottawa)