The debt crisis in Greece churned stock and currency markets around the world Wednesday and the contagion threatened to spread to other European countries, casting a pall over the global recovery.
In Toronto, the stock market fell to its lowest point in about two months and investors fled for the safety of the U.S. dollar, dragging the Canadian dollar to a five-week low against the greenback.
The crisis also shifted expectations on whether the Bank of Canada will boost interest rates June 1.
Market participants now peg the likelihood of a rate hike at 62 per cent. That’s down from 85 per cent just days ago.
Just weeks ago, it was a foregone conclusion that the central bank would raise interest rates to keep a lid on inflation as the housing market, consumer spending, GDP, and the labour market sowed stronger-than-expected signs of recovery.
“The worry is that what’s happening in Greece could actually put a crack in the global growth recovery story and if that happens, it would have an impact on the very sensitive Canadian economy,” said Camilla Sutton, currency strategist at Scotia Capital.
“That combined with general uncertainty about what’s transpiring in Europe has the market worried that the Bank of Canada may not be quite as aggressive as was expected a week ago.”
The crisis “is probably going to make the Bank of Canada more cautious than it otherwise would be,” said economist Michael Gregory of BMO Capital Markets. “We still think the Bank of Canada is going to raise rates on June 1, but the probability is a lot less.”
The crisis showed signs of spreading Wednesday as Moody’s Investors Service warned that it could cut Portugal’s credit rating.
Finance minister Jim Flaherty offered assurances that the crisis is not a direct threat to Canada. “In terms of the Canadian fiscal situation, we are solid ... so it’s not a direct threat to us,” he told reporters in Ottawa.
But he acknowledged it could hurt other countries and banks.
Canada could be affected in several ways, economists said.
Greece and other European nations are slashing spending to control their debt, and that would mean less demand for Canadian oil, commodities, and other exports.
Secondly, jittery investors around the world are likely to demand higher interest rates on long-term debt to compensate them for higher perceived risk.
“That would push up long term interest rates in the bond market and that takes the pressure of the Bank of Canada to raise rates,” Gregory said.
In the meantime, economists expect the market volatility to continue.
“The biggest problem right now is there’s so much uncertainty and there’s a lack of real understanding of what the real threats are. Until that gets cleared up, it makes it very difficult for markets to behave the way we hope they would,” Sutton said.
Last week, Bank of Canada governor Mark Carney told the Senate committee in Ottawa that he does not believe the problems in Green will lead to a second recession, but he said they can hamper the recovery.
“I really doubt that what’s happening in Europe will impact the Bank of Canada in any significant way, at least not in the next few months,” said Benjamin Tal, senior economist with CIBC World Mark