September 7, 2012 / 3:32 PM / in 5 years

Bank of Canada says strong commodities good for economy

Bank of Canada Governor Mark Carney listens to a question during a news conference upon the release of the Monetary Policy Report in Ottawa July 18, 2012. REUTERS/Chris Wattie

CALGARY, Alberta (Reuters) - Bank of Canada Governor Mark Carney said on Friday that high commodity prices are unambiguously good for the economy and he made clear the central bank would not counter commodity-driven increases in the value of the Canadian dollar.

In a speech in Calgary, Carney dismissed the idea put forth by the country’s main opposition party that the economy is suffering from so-called Dutch disease, wherein high commodity prices increase the value of the currency so much that the manufacturing sector is hollowed out.

Canada is a leading exporter of crude oil and its currency has been persistently strong against the U.S. dollar, hammering the competitiveness of manufacturers, many of which export primarily to the U.S. market.

“Most fundamentally, higher commodity prices are unambiguously good for Canada,” Carney said, predicting that sustained global demand for commodities would keep prices elevated.

Carney said any moves by the central bank to curb commodity-driven movements in the value of the Canadian dollar would be futile in the long term. Taking such steps would eventually lead to volatile inflation and employment, and an estimated 1 percent cut in output over five years, he said.

”The logic of Dutch Disease requires that we undo our successes in order to depreciate our currency,“ Carney added. ”Taken to its natural conclusion, this logic dictates that we shut down our oil sands, abandon our resource wealth, have high and variable inflation, run large fiscal deficits and diminish our financial sector.

“Such actions would surely weaken the Canadian dollar, but they would also weaken Canada,” he said.

The Canadian dollar touched its strongest level in nearly a year on Friday after Canadian employment data showed the economy added 34,300 jobs in August, more than expected.

The currency firmed to C$0.9766 against the greenback, or C$1.0240, from C$0.9818, or $1.0185 just before the data was released. That was the Canadian dollar’s strongest level since September 19, 2011.

Carney said commodities explain only about half of the currency’s appreciation over the past decade. The U.S. dollar’s weakness against many major currencies and Canada’s safe haven status for investors explain the rest, he said.

His comments contradicted those of Thomas Mulcair, the leader of the left-of-center New Democratic Party, who argues that rapidly increasing oil output from the Alberta tar sands is driving up the Canadian dollar and harming the manufacturing sector.

Ontario Premier Dalton McGuinty, leader of Canada’s most populous province and manufacturing heartland, has made similar comments.

Dutch Disease originated as a term that was used to describe the decline of Holland’s manufacturing sector as the country’s currency rose after production from a large natural gas field hit full stride in the 1960s.

Carney pointed out that the decline of manufacturing in Canada has been part of a broad trend across the industrialized world. “Canada has not lost ground relative to other advanced economies,” he said.

In a news conference following the speech, the central bank chief did not back down from controversial remarks he made last month criticizing companies for being too cautious and sitting on piles of cash instead of investing it.

“I‘m not pointing fingers at specific companies but the challenge is do we try to wait out ... an adjustment period that is going to go on for at least another five years, probably another decade in advanced economies. Are we going to lower our expectations in the face of that or are we going to deal with the things we can deal with?” he said.

“Individual companies, individuals will make those decisions but the better ones will get on it and already are getting on it.”

Carney did not directly address the issue of monetary policy in his speech after the bank held its key interest rate unchanged at 1 percent on Wednesday.

Financial institutions expect the Bank of Canada to put off raising interest rates until the second quarter of 2013, according to an August 28 Reuters poll.

Writing by Louise Egan and David Ljunggren in Ottawa; Editing by Jeffrey Hodgson; and Peter Galloway

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