OTTAWA — Canada’s central bank must be prepared to rein in the dollar if it gets too high or risk hollowing out the country’s industrial base, CIBC warned Tuesday, adding to calls for Bank of Canada governor Mark Carney to intervene in currency markets.
The warning from the chief economist at Canadian Imperial Bank of Commerce (TSX:CM) comes at a time when the central bank has held out the possibility of intervention, although it hasn’t said it will do so.
The Bank of Canada hasn’t recently used its power to buy and sell huge quantities of Canadian dollars and other currencies to affect the loonie’s value, although it has done so in years past.
“History has shown that intervention, in and of itself without policy moves that are consistent with the direction of that intervention, seldom is effective over the longer term,” Carney told a House of Commons committee Tuesday.
But Carney said the recent rise in the Canadian dollar has created a “downside risk to the economy’s recovery and that the bank has ”considerable options“ to achieve its mandate by maintaining inflation within a target range.
On currency markets Tuesday, the Canadian dollar closed at 93.80 cents US, up 0.08 of a cent. The loonie has dropped in recent days, but economists predict it could hit parity with the U.S. greenback in the next few months, mainly because of U.S. dollar weakness.
At the House committee, Liberal finance critic John McCallum, himself a former Royal Bank of Canada chief economist, asked whether the Bank of Canada has the tools to effectively regulate the value of the dollar given the size of the world’s financial system.
“Maybe you don’t want to reveal your arsenal publicly but, in addition to intervention, what other instruments would you consider for influencing the dollar if you perceive it goes too high?” McCallum asked.
Carney replied that one of the unconventional strategies that it has used is to lower the Bank of Canada’s key interest rates to an all-time low and take the unusual step of saying the rate is likely to stay that low until mid-2010.
He noted the Bank of Canada has also considered, and publicly discussed, the possibility of “quantitative easing.”
Quantitative easing is a tactic in which the central bank could directly buy securities from commercial institutions. The effect would be to increase the number of Canadian dollars in the economy, thus putting downward pressure on the currency’s value and upward pressure on inflation.
“The bank retains considerable flexibility in the conduct of monetary policy,” he said. “We have not had to deploy those instruments beyond the conditional commitment (to the lowest-possibly policy interest rate) . . . but we certainly retain all those other options and would underscore our determination to use those options if it is required . . . in order to achieve the inflation target.”
But he said these other options are on hold for the moment.
“At this stage, we think that the policy suite that we’ve put forward, including the conditional commitment through June 2010, is consistent with (the bank’s) inflation target over the reasonable horizon.”
The governor said the inflation rate is the key.
“What we are concerned with is the effect of the currency exchange rate on all other domestic and international factors and particularly on the inflation rate in Canada and that is what the Bank of Canada’s conduct on monetary policy means.
Carney said that in the Canadian system, the federal finance minister — currently Jim Flaherty — has responsibility for the overall economy.
Historically, the central bank has worked on an ad hoc basis with the finance ministry and other federal and provincial agencies when a crisis erupts, he said.
“I would underscore that the system, in practice, has worked very effectively during the course of this crisis and coming out of this crisis,” Carney said.
But the Bank of Canada, the federal pension and bank regulator, the Finance Department and provincial regulators are working together on a redesign of regulations in the context of what’s being doing by other G20 countries.
In a report Tuesday, CIBC chief economist Avery Shenfeld said the Bank of Canada should intervene during extreme fluctuations of the Canadian dollar.
Shenfeld said a strong loonie has some benefits but they’re outweighed by the long-term damage that would be caused by an over-valued currency.
Canadian manufacturing plants that can’t compete with a persistently over-valued currency could be forced to close, and won’t come back even if the loonie returns to fundamentals, he said.
Elsewhere, the Export Development Corporation issued its own report Tuesday warning that a 95-cent dollar could lop two to three percentage points off growth from the Canadian economy next year.
The Crown corporation says it expects exports to increase six per cent next year, but that is a minor improvement given that 2009 will see a 29-per-cent tumble from what Canada sold to the world in 2008.