In a snap, the Canadian dollar reversed course Tuesday after the Bank of Canada signalled its commitment to higher interest rates as concern over rising household debt levels trump worries about exporters.
"Some modest withdrawal of monetary policy stimulus" will likely be needed "over time," the central bank said Tuesday, causing an instant pop in the Canadian currency.
Traders had placed bets in recent days that the Bank of Canada would take the prospect of rate hikes off the table in today's statement, especially after Governor Mark Carney made no reference to potential rate increases in a speech this month.
They were wrong. The Canadian dollar erased losses in morning trading, touching 1.008 (U.S.), after the currency hit a 10-week low earlier in the session. Canada remains the only country in the G7 with leanings towards higher borrowing costs.
The bank emphasized that it will taken into consideration rising household debt levels in any future decisions. Canadian households are carrying record debt relative to disposable income -- 163.4 per cent in the second quarter, levels close to those of U.S. and the U.K. just before their housing market's crashed.
The bank is fully aware that its statement would send the Canadian dollar higher. But it included a new nod to debt worries, saying the timing and extent of rate hikes will depend in part on the "evolution of imbalances in the household sector."
It acknowledges the impact that sustained currency strength will have on Canada's manufacturing sector.
Canadian exports are expected to pick up "gradually," it said -- but they will remain below their pre-recession peak until the first half of 2014 due to weak foreign demand and ongoing competitiveness challenges.
"These challenges include the persistent strength of the Canadian dollar, which is being influenced by safe haven flows and spillovers from global monetary policy."