The Bank of Canada seems pretty intent on ignoring, as much as possible, the raging Canadian dollar. In most instances, that would be a bad idea. In the current circumstances, it may be good policy.
In the statement accompanying the bank’s stay-the-course interest-rate decision on Wednesday, the bank addressed the usual suspects influencing its economic outlook and the path of monetary policy. It talked about the COVID-19 pandemic and vaccinations, about rising inflation, about the state of employment and the prospects for a consumer-led recovery.
Oh, and it mentioned the dollar, which last week topped 83 cents (U.S.) for the first time in more than six years, and has skyrocketed more than 20 per cent in a little over a year.
“Commodity prices have risen further, notably oil, and the Canadian dollar has seen further appreciation.”
That was all, and about the least the bank could possibly get away with. (“Oh, hey, there’s an elephant in the room. Could you pass me the chips? How about those Canadiens!”)
There are good arguments that the bank should be expressing more concern, publicly and loudly. At its current heights, the dollar is three cents higher than the level on which the central bank based its most recent economic forecast, in April. It’s five cents higher than in the bank’s forecast in January. It’s undeniable that this much appreciation, that quickly, is material to the bank’s outlook.
When Bank of Canada Governor Tiff Macklem was asked about the currency during a news conference in mid-May, he characterized the rise as largely justified by rising prices for Canada’s commodity exports. “That’s good news for Canada,” he said.
However, he did allow that “if” the dollar rose well beyond the underlying positive fundamental factors supporting it, “it’s something we’d have to take into account in our setting of monetary policy.”
In a paper published last week, Canadian Imperial Bank of Commerce economists Avery Shenfeld and Royce Mendes argued that the boom in commodity prices may prove relatively short-lived, a product of the snap-back of global demand as economies reopen from pandemic shutdowns. But the accompanying spike in the Canadian dollar throws a pretty heavy anchor to exports, competitiveness and investment in non-resource industries – which actually represent the majority of Canada’s exports.
Mr. Shenfeld and Mr. Mendes suggested the Bank of Canada could and should help cool the enthusiasm for the loonie, by dropping its calm rhetoric around the currency and “explicitly” reminding the forex market that the strong dollar is a serious drag on exports and inflation and, by extension, the timing of future interest-rate increases. They noted that Mr. Macklem’s predecessor, Stephen Poloz, delivered this sort of message when he took office in 2013, “and it visibly moved the needle on the exchange rate.”
The market’s preconceived notions about Mr. Poloz certainly played a major role in how his comments on the Canadian dollar were taken. He had come to the governorship from the top job at Export Development Canada, and many observers viewed him as a pro-business and pro-export appointment – one who would favour a weaker-dollar policy. Anything he said about the currency in his first year or so on the job was readily interpreted as supporting those assumptions, even if, in reality, he really wasn’t saying anything particularly bold or different about the currency.
It’s unclear whether similar comments from Mr. Macklem, who didn’t come to the job with the same pro-export reputation, would carry the same weight.
Regardless, Mr. Macklem might be better off biting his tongue. Given some of the other issues he faces over the next several months, a strong dollar might actually help.
The two biggest concerns standing in the path of the Bank of Canada’s monetary policy – its gradual reduction of its quantitative easing program and eventual raising of interest rates – are the pace of inflation and economic growth. A sustained overheating of either – something that has become a serious concern as reopening gains momentum – could force Mr. Macklem to remove monetary stimulus earlier and faster than he would like.
A strong Canadian dollar leans against growth in export-oriented segments of the economy, acting as a brake on the surging demand from foreign markets. At the same time, the currency gains serve to reduce the cost of imports for Canadian buyers – thus cooling some powerful sources of inflation that have begun to emerge, namely, rising cost pressures for overseas makers of consumer goods.
The higher dollar can, in broad terms, achieve some of the same goals as an interest-rate increase – without the rate increase. The currency can buy time for Mr. Macklem and his Bank of Canada colleagues.
The emergence from the pandemic may be almost as jolting an economic shift as the descent into the crisis. The central bank has long talked about the country’s flexible exchange rate as a natural shock absorber in such times. Maybe the wisest thing for Mr. Macklem to do right now is keep quiet and let the currency do its job.
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