Bank of Canada Governor Mark Carney is done with nuance. His new message for those who doubt he's prepared to weaken the dollar if Canada's recovery veers too far off track: Just watch me.
Mr. Carney used the release of the central bank's latest quarterly economic report Thursday to explain in the clearest terms yet how the currency's surge is impeding the recovery and why he will adjust policy if the loonie continues its current trajectory.
Despite stronger than expected growth in the second half, the central bank has actually reduced its outlook for the next two years, saying that's when the current appreciation of the currency will show up in growth figures.
That's dampening what little inflation exists in the economy, which is troubling for the Bank of Canada because it's mandated to keep prices advancing at a rate of about 2 per cent a year. The central bank now says inflation won't return to the target until the third quarter of 2011 - three months later than was expected in July.
Given that backdrop, Mr. Carney said he would have no choice but to act if international investors continue to push the dollar higher - something they've been quite willing to do, in part because most analysts and investors are skeptical a central bank that hasn't intervened in currency markets since 1998 is willing to back up its talk with action.
"Markets should take seriously our determination to set policy to achieve the inflation target," Mr. Carney said. "Markets sometimes lose their focus. We don't lose our focus."
This week could prove to be a pivotal moment in Mr. Carney's four-month verbal campaign against the international investors who, after flocking to U.S.-dollar denominated investments at the height of the crisis, are now fleeing the United States, which is facing a sluggish recovery and a record budget deficit.
The flight from the U.S. intensified after the Reserve Bank of Australia increased its benchmark interest rate earlier this month, creating an impression among some investors that other big producers of commodities, such as Norway and Canada, would follow suit.
Mr. Carney's comments, coupled with the central bank's latest analysis, were meant to remove Canada from that calculation.
At the same time, Mr. Carney is trying to avoid direct intervention by convincing investors that their lust for Canadian assets actually risks undermining the strengths that attracted them in the first place.
If he's persuasive, he may have already laid the groundwork for a recovery, if only a gradual one. If he's not, he faces the difficult choice of making a direct assault on the currency by boosting the supply of loonies, which would theoretically lower the value.
So far, so good. The Canadian dollar fell to 95.44 cents (U.S.) Thursday from 95.60 cents, the third consecutive day the loonie traded below 96 cents, according to the Bank of Canada's closing price.
The currency is 16-per-cent higher from the start of the year.
"It was like a good actor reading his script, it was that good," Sébastien Lavoie, an economist at Montreal-based Laurentian Bank Securities and a former analyst at the Bank of Canada, said of Mr. Carney's comments Thursday.
"The odds of currency intervention within the next year are higher than a rate hike," Mr. Lavoie said.
The international demand for Canadian dollars appears to have broken from its traditional link to oil and other commodity prices, the central bank said.
After trading in a range of 90 to 94 cents from July to October, the currency "appreciated sharply" to average about 96 cents over the past 10 days, a move the central bank attributed to "a broader depreciation of the U.S. dollar against most major currencies."
When the currency appreciates largely as the result of speculative portfolio flows, the central bank believes the gain has a net negative effect on the economy because a stronger currency makes Canadian exports less competitive in global markets and companies earn less on sales of goods priced in U.S. dollars.
In July, the central bank projected the loonie would trade at around 87 cents. Its revised assumption is that the currency will trade at around 96 cents for the next quarter.
For now, Mr. Carney said he is content with his current policy stance, which is encompassed by the extraordinary pledge he made in April to leave the benchmark interest rate near zero until at least June, 2010, conditional on the inflation outlook. With the central bank forecasting slower inflation this week, the odds increased that the central bank will follow through on that promise.
But if the currency continues to surge, Mr. Carney stressed that he retains "considerable flexibility" to stoke the demand required to get inflation back to the 2-per-cent target. His options would include creating money to buy U.S.-dollar denominated assets or direct intervention in foreign exchange markets.
"Depending on the sum of events that happen going forward, we will adjust policy going forward in order to achieve that target," Mr. Carney said. "The markets shouldn't underestimate that."