Hedge funds and derivatives not a big worry for Bank of Canada governor

TORONTO (CP) - There are economic factors that cause anxiety for the governor of the Bank of Canada, but hedge funds and derivatives are not among them.

New financial techniques - so far - have lived up to their promise of redistributing risk away from banks and into hedge funds, pension funds and other institutions more willing to bear it, David Dodge said after a speech Thursday.

"We have a lot of innovative financial instruments that have been developed since I became governor a mere six years ago," he told a luncheon-speech questioner.

"On balance, that redistribution of risk because of the new instruments is really quite a positive thing."

He also acknowledged that central banks "don't absolutely fully understand how all these new instruments have moved risk around the economy and how they have fully affected what central banks can do in affecting liquidity."

However, "so far the delivery by the new instruments has confirmed the promise of them to better distribute risk and reduce the overall risk in our financial system."

In his speech, Dodge said prospects for the Canadian economy are solid for 2007 after sluggishness in the last half of 2006, but the major anxiety centres on the U.S. economy.

He said growth should hit an annual rate of 2.75 per cent in the second half of this year, well above the 1.6 per cent estimated for the second half of last year.

The "major downside risk" is that the recent downturn in the American housing market and slackness in the U.S. automotive sector still have significantly further to run, he said, but the bank is projecting a benign outcome.

"Since October we have had a fair bit of adjustment take place without an absolute collapse in U.S. housing prices and without a real spillover to other parts of the U.S. economy," Dodge told reporters.

"That gives us a fair bit more confidence going forward."

Still, the United States now has a bulky stock of unoccupied homes, "so it is going to take a while for this to work its way off, and U.S. housebuilding - in particular singles, which is most important for what we export - is going to be relatively weak as we look out over the next two or three quarters."

His speech, largely recapitulating the monetary policy update the Bank of Canada released last week, noted another ongoing risk: "the possibility of a disorderly resolution of global imbalances."

It's difficult to assess the risk posed by these imbalances - massive debts in the United States and huge savings in Asia and the oil-producing countries - but Dodge sees no immediate threat.

"As long as market participants have reason to believe that policy makers worldwide will take appropriate actions, there is no reason to expect that these imbalances won't be unwound in a gradual and orderly way," he said.

Dodge reiterated his previous calls for the International Monetary Fund to be given a more effective mandate to monitor the global economy.

"The risk of a disorderly resolution of global imbalances may be relatively small, but it remains an important risk for all of us, and strengthening the IMF is one way of reducing this risk."