RBC Economics says that the speech by Bank of Canada deputy governor Pierre Duguay to the Canadian Association of Business Economists last night confirms the expectation that the central bank will be slow to raise rates in light of recent financial market turmoil.

The firm says that Duguay’s speech, “seemingly prepares the way for the central bank to move onto the sidelines and monitor the impact of the recent financial market turmoil.”

“The speech indicated that turmoil was prompted by a ‘reassessment of risk in credit markets triggered by concern about exposure to the U.S. sub-prime mortgages’. However, the repricing was aggravated due to ‘insufficient transparency – both about the actual assets that are backing these securities and about the distribution of exposure to these assets’. The turmoil resulted in ‘difficulties’ in the market for asset-backed commercial paper and ‘the drying up of liquidity in money markets more generally’,” RBC reports.

In response to the turmoil, the Bank of Canada undertook a number of measures largely designed to increase liquidity in the system, RBC notes, “However, Duguay stressed that operations did not reflect any easing in monetary conditions but, instead, were designed to counter the illiquidity that had taken hold in financial markets.”

“Looking ahead, Duguay commented that the economic data released since the July Monetary Policy Report Update were generally in line with expectations,” RBC says, adding, it was those economic conditions that resulted in the Bank of Canada raising the overnight rate 25 basis points to 4.50%.

“However, the speech then went on to quickly warn that, given the recent financial market turmoil, the central bank needed to reassess the outlook provided in July. Duguay indicated that two questions would need to be resolved: First, how much greater is the risk to the Canadian economy now posed by developments in the U.S. economy? And second, to what extent would the re-pricing of credit risk lead to a sustained tightening of credit conditions in Canada?” it says.

“Given the continuing nervousness in financial markets, it is unlikely that the central bank will be able to satisfactorily answer these questions by the next policy meeting September 5,” RBC concludes. “This speech is generally consistent with our view that the Bank of Canada will move onto the sidelines at this meeting, opting to continue to monitor trends in both financial markets and the economic data. Our forecast assumes that the Bank of Canada will not return to tightening mode until early in 2008.”