OTTAWA (Reuters) - Bank of Canada Governor Mark Carney said on Tuesday he would not hesitate to take steps to slow the Canadian dollar's rise if it became clear that market speculators were pushing it to unrealistic levels.
He said the strength of the currency, which this month reached parity with the U.S. dollar, reflects several factors including a strong economy, strong fiscal position and rising commodity prices.
Even so, he said currency strength is one of the main challenges to the Canadian economic recovery.
"I would say that persistent strength in the Canadian dollar is a risk," Carney said in testimony before the House of Commons finance committee.
"We've only identified two major downside risks to the Canadian outlook and the dollar is the first. So it's something we watch closely and it could have an important influence on both economic activity and the outlook for inflation. The bank will set policy appropriately in those circumstances," he told legislators.
"Markets sometimes overshoot and we should be conscious of that. For those reasons, the bank, in agreement with the minister of finance, have additional tools to address those situations. And no one should be under any illusions that we wouldn't use them," he added.
The Canadian dollar dropped more than a 1-1/2 cents against the greenback on Tuesday on fears about sovereign debt levels in Europe after Standard & Poor's slashed Greece's debt rating to junk status, which spurred a flight to safety.
But it has added to gains after a 15.9 percent rally last year and this month traded at its strongest since June, 2008.
Carney declined to give guidance on the future path of interest rates after laying the groundwork last week for hiking rates from record low level of 0.25 percent, saying it was time to start withdrawing some of the unprecedented monetary stimulus that helped pull Canada out of recession.
A poll following its most recent rate-setting decision showed most of Canada's primary securities dealers think the bank will raise interest rates in June.
The key to Canada's recovery is the private sector investment, which has lagged behind consumer spending so far, Carney said.
"What has been lower than the general experience in recessions has been business investment. Our forecast ... is that we see the recovery of business investment basically from now going forward and that that picks up over the forecast horizon (to end of 2012)," he said.
Carney said most businesses were able to access financing, but that credit conditions for small and medium-sized businesses were still tight.
"Large enterprises obviously have the benefit of access to capital markets, which are quite open at this stage," he said.
Reporting by Louise Egan; editing by Jeffrey Hodgson