KINGSTON, Ontario (Reuters) - The Bank of Canada issued another warning on Tuesday about the strong Canadian dollar threatening the country's economic recovery, which it sees occurring in the third quarter.
"Other things being equal, a persistently strong Canadian dollar would reduce real growth and delay the return of inflation to target," Deputy Governor Timothy Lane told economists in his debut speech as central banker.
"If a stronger dollar were to alter the path of projected inflation relative to that presented in our July Monetary Policy Report, we would need to take that into account," he said.
Lane said the Bank of Canada has the tools at its disposal to handle the appreciating currency. But with interest rates at a historic low of 0.25 percent, the options are limited and most economists think the bank will confine itself to verbal intervention to get speculators to back off the currency.
"They could intervene in foreign exchange markets but quite frankly I don't think that's the signal we're getting at the moment. I don't think we're getting a message here to get ready for intervention," said Craig Alexander, deputy chief economist at TD bank.
The Canadian unit, which had pared early gains against the U.S. currency as oil prices fell, weakened further after Lane's remarks were published. The currency, which has rallied about 20 percent from a four-year low in March, hit a session low of C$1.0870, or 91.99 U.S. cents, after the speech.
Lane said some of the currency's rise had stemmed from factors like higher commodity prices that are leading to a Canadian recovery. Traditionally, the bank has said it would not counter foreign exchange movements based on such factors.
However, he also said it was a result of a more generalized weakening of the U.S. dollar as global financial conditions normalize.
One unconventional policy the bank could take is quantitative easing, which refers effectively to the printing of money. Lane repeated the bank's conditional commitment to keep rates at their current low until mid-2010 and analysts say the bank could opt to hold rates for even longer if the currency strength persists and delays recovery.
A second important risk to the Canadian recovery is that a good deal of the recovery so far had come from fiscal and monetary stimulus, and Lane said there was a risk that private demand would not emerge as fast as desired.
"At what stage will private demand be robust enough to make the recovery self-sustaining? Clearly, we haven't reached that point yet," he said.
Despite the obstacles, Lane was cautiously optimistic that Canada's recession would end in the third quarter but said the recovery would be "sluggish" and "muted" and that financial conditions have not yet returned to normal.
"Two years after the onset of a global financial crisis and after three quarters of severe recession in Canada, the economic outlook for this country, and much of the world, has improved," he said.
He said Canada's recovery would be supported by factors which would make it "somewhat more robust" than elsewhere.
First, recovery in hard-hit U.S. sectors like housing and cars will benefit Canadian exporters. Second, Canada's financial system is functioning well. Third is the underlying strength of household, business and government balance sheets.
Lane, a former advisor with the International Monetary Fund, was named a deputy governor of the Bank of Canada last February. His speech to the Canadian Association of Business Economics was his first in his new role and laid out some of the long-term challenges to achieving improved living standards in Canada after the crisis blows over.
Economists in the audience commented that he largely followed the script set out by the central bank in its report last month.
With additional reporting by Randall Palmer; Editing by Jeffrey Hodgson