Bank of Canada Governor Mark Carney has a problem: Many investors are having a hard time believing that he would actually tailor monetary policy to slow the loonie's ascent.
Mr. Carney went out of his way early last month to signal displeasure with the dollar's record surge in May, an unusually aggressive stand for a central banker who prefers to remain silent about the decisions of private investors.
In the Bank of Canada's last policy statement, and then in public appearances that followed, Mr. Carney warned that the “unprecedentedly rapid rise” of the dollar risked snuffing out early signs of an economic recovery.
Beginning Tuesday with the release of the central bank's latest policy statement, and again on Thursday when policy makers publish their latest quarterly report on the economy, Mr. Carney will have the opportunity to convince skeptical traders of his intentions.
Perception is key.
If the traders making a speculative play on the dollar fear the central bank could push back, they will be less likely to bid up the value of the loonie against the U.S. greenback. If those traders decide warnings from the central bank are just so much talk, they will proceed with their bet on the dollar and make life difficult for Canadian exporters.
The Canadian dollar's roller-coaster ride this year is already a headache for exporters.
Exporters are fighting over scant orders amid the biggest collapse in world trade since the Second World War. The more they struggle, the more difficult it becomes for policy makers to generate the economic growth they need to get the annual inflation rate back to their target of 2 per cent.
Mr. Carney's tough talk last month appeared to work at first.
The dollar tumbled back to earth over the remainder of June and into July. But last week, the loonie suddenly found new life, jumping 4.6 per cent, a reminder of how difficult it is to tether a currency that has become linked to commodity prices and has become a favourite of hedge funds and others who profit by speculating in foreign exchange markets.
The state of the U.S. remains the biggest worry for the Bank of Canada. The halting recovery of the world's largest economy and Canada's biggest trading partner ensures that the central bank will conclude its latest round of policy meetings this morning with a decision to recommit to its plan to leave the benchmark interest rate at a record low of 0.25 per cent until the middle of 2010.
But if the U.S. is the biggest concern, then the volatility of the currency is Mr. Carney's biggest frustration.
Deflation is no longer a serious threat, as the central bank's quarterly survey of business managers showed last week that 84 per cent expected prices to increase at an annual rate of between 1 and 3 per cent over the next two years.
For the first time in 43 cash auctions dating back to September, the Bank of Canada didn't release all the funds on offer July 13, a signal that credit markets are getting stronger.
And consumer confidence appears to be holding up even as unemployment rates rise. Sales of existing homes rose 8.7 per cent in June, the fifth consecutive monthly increase, the Canadian Real Estate Association reported last week.
That leaves the currency.
Canada's economic growth won't return to steady annual increases of about 3 per cent that were the norm in the years before the crisis without a boost from trade. The Bank of Canada said in April that the collapse of global trade would subtract 4.6 percentage points from gross domestic product this year, by far the biggest blow to the economy. By comparison, trade contributed 1.3 points to GDP in 2005.
