Bank of Canada Governor Mark Carney says he is prepared to intervene in currency markets if the Canadian dollar's rise persists and threatens to smother the “nascent” recovery.
Mr. Carney issued the gentle warning to currency traders after releasing the central bank's latest monetary policy report, which predicts gross domestic product will expand at an annual rate of 1 per cent over the next three months, implying the recession will end one quarter sooner than policy makers previously expected.
The Bank of Canada's new projections show consistent, yet muted, quarterly growth through to the end of 2011.
This suggests policy makers believe they can nurture the country's economy back to a healthy condition without it slipping back into a state of decline.
The outlook relies heavily on the belief that the economic contraction in the United States “is at its trough,” and that Canada's exporters will benefit disproportionately from the rebound because of their strong trade links with the world's largest economy.
Policy makers flagged the dollar, which climbed to a seven-week high of 92.04 U.S. cents yesterday, as the biggest risk to their outlook because a higher currency makes exports less competitive.
“Importantly, a stronger and more volatile Canadian dollar could act as a significant drag on growth and put additional downward pressure on inflation,” the central bank said in its latest monetary policy report.
The Bank of Canada is mandated by law to keep consumer prices advancing at an annual rate of about 2 per cent. Policy makers have dropped their benchmark lending rate to a rock-bottom 0.25 per cent in order to nurture enough economic activity to avoid deflation, and Mr. Carney recommitted yesterday to leave that rate unchanged until the middle of 2010, barring an unexpected burst of inflation.
Much of the currency's 14-per-cent rise since the Bank of Canada's last economic report on April 21 is related to rising commodity prices.
But policy makers said Thursday that the gain also is the result of “generalized weakening of the U.S. dollar,” which implies the central bank believes that speculators are playing a role in the loonie's ascent.
Mr. Carney, who normally eschews commenting on investors' decisions, is fighting against a widely held perception that the Bank of Canada would almost never tailor policy to alter the value of the currency. The Canadian central bank hasn't intervened in currency markets since 1998, and it has a stated policy to do so only in extreme circumstances.
Rhetoric also is becoming necessary because the lending rate is so low. If the overnight target was higher, the central bank could drop it in order to make Canadian interest-bearing assets less attractive.
“The bank retains considerable flexibility, and we will use that flexibility if necessary,” Mr. Carney said at press conference Thursday in Ottawa.
The Bank of Canada noted in its monetary policy report that “other commodity currencies” also are rising.
While Mr. Carney said that the financial crisis hasn't caused the Bank of Canada to reconsider its intervention policy, he stressed that policy makers would act if the dollar rose to the point that it risked knocking their outlook off course. “We are watching it very closely,” he said.
“It's a risk. It's a risk.”
