The Bank of Canada held its key interest rate unchanged on Thursday at 0.25 percent, as expected, but sent a shot across the bow of currency markets with unusually strong comments on the threat posed by the sharp appreciation of the Canadian dollar.
The central bank reaffirmed its pledge to hold rates where they are for another year. It made no mention of unconventional monetary easing, such as printing money to buy securities, upholding its view that further stimulus is not required any time soon. It made note of recent significant improvements in financial conditions and commodity prices and a modest recovery in consumer and business confidence.
But the bank said all of that could be lost if the Canadian dollar - which rose 9.3 percent against the US dollar in May - continues to rise. The dollar climbed to an eight-month high around C$1.08 to the US dollar, or 92.5 US cents, earlier this month, before settling around C$1.1050, or 90.5 US cents, on Thursday. It weakened slightly on the Bank of Canada announcement.
"If the unprecedentedly rapid rise in the Canadian dollar (which reflects a combination of higher commodity prices and generalised weakness in the US currency) proves persistent, it could fully offset these positive factors," the bank said. Economists had anticipated a comment on the currency by the central bank, but few thought Governor Mark Carney would go so far in his verbal intervention, especially since he has been reluctant to judge the currency's value in the past.
"It's a bolder comment than I would have expected...By central bank language that's a pretty bold acknowledgement of the downside risks that appreciation poses to the Canadian economy," said Derek Holt, economist at Scotia Capital. Until recently, Carney had been listing the past depreciation of the Canadian dollar as a factor supporting the economic recovery.
NO URGE TO SPLURGE: Beyond the dollar comment, the bank said little new. It has no plans to buy securities in the market like the US Federal Reserve or the European Central Bank. And it made no comment on fiscal policy, unlike Fed Chairman Ben Bernanke, who issued a warning on Wednesday on the giant US deficit. "No new policy measures undertaken. So no urge to splurge further for the Bank of Canada," said Sal Guatieri, senior economist at BMO Capital Markets.
The bank cut its overnight target interest rate in April and promised to keep the rate steady until the end of June 2010, provided there is no significant change to its outlook on inflation. It also detailed the additional tools at its disposal to stimulate the economy, but signalled it had no immediate plans to use them. Primary securities dealers polled by Reuters this week saw a low probability of unconventional easing over the next 12 months.
On Thursday, the bank said the upside and downside risks to the Canadian economy were roughly balanced. But it reiterated its April comment that there is a bigger risk that inflation could be lower than projected. This is because it can no longer cut interest rates, which are already at their floor, to boost prices. The bank has already built into its forecast a bout of falling prices in the second and third quarters.