The Bank of Canada’s angst over low inflation sent the dollar into a nosedive, but Governor Stephen Poloz says a cheaper currency is simply the “icing on the cake” for an economy that will be driven by stronger U.S. growth.
The bank gave no signal on future interest rate moves as it kept its key overnight rate unchanged at 1 per cent, where it has been since September, 2010, and maintained its official neutral stance on the direction of its next move. But the bank’s language about inflation and currency caused the loonie to drop sharply.
“We are more concerned about low inflation today than we were three months ago,” Mr. Poloz explained to reporters after the central bank’s first rate announcement of 2014. The bank said in its monetary policy report that it still views the dollar as strong enough to “pose competitiveness challenges for Canada’s non-commodity exports.”
The change in tone sent the dollar down nearly a full cent to 90.19 cents (U.S.) Wednesday, its lowest level in more than four years. The currency has now lost nearly 7 cents since Mr. Poloz joined the bank in June.
A cheaper dollar makes most imported goods more expensive – from autos to flat-screen TVs. But it’s a relief for manufacturers and local tourism operators, who have struggled for the past decade when the loonie soared to par with the greenback and beyond.
Mr. Poloz said devaluation is generally a good thing for the Canadian economy. But he flatly denied he’s responding to political pressure from the Conservative government and talking down the dollar.
“There is very little doubt that it is, to a degree, positive,” he said of dollar’s recent slide. “The increase in U.S. demand is the most important thing. That’s the cake. If the exchange rate is going down a little and [it] gives us a little bit of a marginal boost, that’s the icing on the cake.”
Inflation was running at a rate of less than 1 per cent annually in the fourth quarter. The Bank of Canada issued a new inflation forecast, showing that its 2-per-cent target won’t be reached until early 2016. The bank blamed the more sober projection on “widespread and persistent competition among retailers,” along with “significant” slack in the economy.
The bank put a figure on the so-called “Target effect” of intense price competition – 0.3 percentage points off core consumer prices in 2014.
Bank of Montreal chief economist Douglas Porter said Mr. Poloz is getting what he wants – a lower dollar – without actually cutting rates to get it. “Suffice it to say that the bank is welcoming the weakening Canadian dollar with open arms,” Mr. Porter said.
While the falling dollar is a boon to most Canadian exporters, it is bad news for those companies that import products to sell here, and have to pay for them with a weakening currency.
“It is going to impact us,” said Matt Campbell, chief executive officer of Rocky Mountain Dealerships Inc., a Calgary-based chain of dealers that sells imported agricultural and construction equipment. “On a $400,000 machine, if the dollar moves eight points, that’s a lot of dough.”
Some of the company’s suppliers may absorb the difference – at least for a while – but eventually there will be pressure to raise prices in Canada, especially if the dollar continues to fall, Mr. Campbell said.
At Paladin Labs Inc., a Montreal firm that markets dozens of imported specialty drugs across Canada, chief financial officer Samira Sakhia said the falling loonie is a concern despite the fact that the company has some agreements to buy its products in Canadian dollars.
The volatility of the dollar is the biggest concern to Paladin because it wreaks havoc on corporate planning, she said. At the same time, the company can’t stock up on drugs when the dollar is high, because the products have expiry dates and can’t be held indefinitely.
The Bank of Canada pointed out that disinflation – which means a falling rate of price inflation – is part of a pattern now seen in most advanced economies, caused by lower prices for many food items and lingering effects of the deep global recession.
Cutting interest rates would spur more inflation. But it would also encourage already heavily indebted Canadians to borrow more and fuel already steep home prices.
Not one of the 37 economists polled by Reuters last week expects the Bank of Canada to cut rates over the next two years. All are forecasting a rate increase, with a median expectation of mid-2015.