Bank of Canada Governor Mark Carney won't be losing sleep over the Canadian dollar's latest rush toward parity with the U.S. dollar as he charts a steady course toward interest rate hikes later this year.
In contrast to the central bank's alarm a few months ago when the Canadian dollar shot up sharply and markets speculated at some form of intervention, the bank can be more sanguine now, even though the currency has appreciated 6 per cent in less than six weeks to near 20-month highs.
Mr. Carney looks able to comfortably keep his promise to hold interest rate at an all-time low of 0.25 per cent until the end of June, provided inflation stays tame.
Market players had begun to price in an earlier rate hike as the economy heated up fast after the recession. The very prospect of Canada raising borrowing costs ahead of the United States lured in foreign investors and bolstered the currency, which was already riding high on commodity prices.
But analysts said the strong currency could have the same effect as a rate hike and dampen inflation .
"There's a bit of circular logic here," said Doug Porter, deputy chief economist at BMO Capital Markets. "The further (higher) the Canadian dollar goes, the less need there is for the bank to begin tapping the brakes."
Understanding the Canadian dollar: A four-part series
The bank has given no clue when it might start raising rates. Market players still expect tightening to start in July, but yields on overnight index swaps show the odds on a July rate hike have narrowed slightly.
A strong Canadian dollar could push a rate hike back to September or beyond, and rule out big 50 basis-point hikes.
Analysts say Mr. Carney may want to avoid a repeat of 2002 and 2003, the last time Canada hiked rates while the Fed did not.
In that period, Canada cranked up rates by 1.25 percentage points while the Fed lowered rates. The Canadian dollar responded with its biggest one-year percentage gain on record.
In mid-2009, the Bank of Canada and Finance Minister Jim Flaherty began openly musing about possible action to brake the Canadian dollar, fearing that an unprecedented one-month gain in May and months of volatility could reverse the economy's emergence from a crippling crisis.
This time the currency has risen more gradually - analysis by Toronto-Dominion Bank shows the current appreciation is less than half as fast as in the second quarter of 2009.
"So far the Canadian dollar doesn't seem to be a huge concern, but it could become one if the currency begins to move too much faster, even if supported by fundamentals," the bank said in a note.
Mr. Carney is likely keeping a close watch on the currency and markets say he may address the issue in a March 24 speech.
He may echo government officials who have suggested manufacturers and exporters are better prepared to cope with a strong dollar, and focus on data that shows the economy is gaining strength.
"Economic data seems to be coming in generally in stronger than expected, starting with the fourth-quarter growth numbers," said Paul Ferley, assistant chief economist at Royal Bank of Canada.
"They (Bank of Canada) wouldn't view the strong dollar as prompting a greater than warranted drag on growth, but that the strength is consistent with higher commodity prices and facilitating the economy's adjustment to that."
January manufacturing sales of 2.4 per cent, the fifth consecutive monthly increase and far stronger than expected, suggest first-quarter growth may almost be as strong as the 5 per cent annualized rate in the fourth-quarter, analysts said.
If evidence continues to suggest the Canadian dollar's gains are largely justified, "then we can be fairly calm about the appreciation of the loonie," said Finn Poschmann, vice president of research at the C.D. Howe Institute think tank.