PICKERING, Ontario (Reuters) - The finance minister raised the possibility on Tuesday of policy makers intervening in the currency market if the Canadian dollar's sharp rise puts the fragile economic recovery at risk.
Immediately after Flaherty's comments, the Canadian dollar fell against the U.S. dollar after hitting a 10-month high earlier in the day.
Currency matters in Canada are strictly the domain of the Bank of Canada, not the government, and so far few market players are betting the bank will step in to brake the appreciation.
"I won't substitute my views for those of the governor of the Bank (of Canada) ... We are concerned with any rapid changes in the valuation of the Canadian currency vis a vis the U.S. currency ... We watch that," Flaherty told reporters.
"There are some steps that could be taken to dampen that. There are, from time to time, indications of some speculation in the Canadian currency that is not justified in market terms," he said.
The Canadian dollar rose as high as C$1.0632 to the U.S. dollar, or 94.06 U.S. cents, on Tuesday, up 1.3 percent from Friday, before paring gains. Monday was a market holiday in Canada.
After Flaherty spoke, the currency fell to C$1.0756, or 92.97 U.S. cents. It later rebounded to close at C$1.0745 to the U.S. dollar, or 93.07 U.S. cents, up from Friday's close of C$1.0775 to the U.S. dollar, or 92.81 U.S. cents.
Matthew Strauss, senior currency strategist at RBC Capital Markets, said the reversal in the currency's movement was caused entirely by Flaherty's comments rather than the more frequent reason of a change in U.S. risk sentiment.
"What the market really latched on to was his comments on there are some steps that could be taken to dampen the Canadian dollar rise," he said.
"It's the concern of foreign exchange intervention," Strauss said.
Last month, Bank of Canada Governor Mark Carney did not rule out taking additional policy action if the Canadian dollar remained persistently higher than the 87 U.S. cents projected in the central bank's quarterly report.
Canadian exporters, the backbone of the economy, are hard hit by a strong currency as they receive most of their sales revenue in U.S. dollars.
The Bank of Canada has not intervened in the foreign exchange market since September 1998 and Carney said currency intervention is only effective if backed up by other policies. The bank retains "considerable flexibility" in this regard and will use that flexibility if necessary, he said.
The central bank has cut its benchmark interest rate to a floor of 0.25 percent and if it wants to stimulate the economy further, it would have to resort to creating money and buying bonds in the market -- a step called quantitative easing.
Potentially, Carney could do a combination of quantitative easing and selling of Canadian dollars to buy foreign currencies.
Reporting by Ka Yan Ng, writing by Louise Egan, additional reporting by Jennifer Kwan; editing by Rob Wilson