OTTAWA (Reuters) - The Bank of Canada warned on Wednesday that the country’s improving economy faced downside risks, including a stronger currency that could drag on non-commodity exports, even as it held interest rates steady and raised growth forecasts.
Citing weaker global growth, a less favorable U.S. outlook and shrinking business investment, the central bank said fiscal stimulus in the new Liberal government’s first budget was one of the only positive factors driving an economy still feeling the shock of an oil price slump.
“The negative things that are still in the world and still headwinds pushing us back, my guess is that over the next two years those will continue to some degree,” Bank of Canada Governor Stephen Poloz told a news conference.
As expected, the bank held its overnight rate at 0.5 percent, where it has been since last July. But it was Poloz’s tightrope walk about the Canadian dollar, which briefly hit a nine-month high on Wednesday, that perked up the ears of market-watchers.
Poloz noted that the currency’s sharp recovery from a 12-year low in January reflected firmer commodity prices, but said it could put at risk a much-needed recovery in non-resource exports.
Emanuella Enenajor, North America economist at Bank of America-Merrill Lynch, called the comments “jaw-boning light,” referring to a central bank strategy of using commentary to try to influence a currency.
“The bank is walking a very fine line in terms of their communication. Anytime there is something positive mentioned there are a couple of headwinds that are also footnoted,” she said.
The Canadian dollar firmed immediately after the central bank rate decision, but later weakened. [CAD/]
Poloz told BNN news channel that he rejected the interpretation that the central bank has a weaker Canadian dollar agenda.
Michael Goshko, corporate risk manager at Western Union Business Solutions, said Poloz appeared wary of encouraging Canadian dollar volatility, but could easily cap further gains in coming months.
“If he were to imply a continued strengthening in the currency is undesirable, traders would jump on that,” Goshko said.
Poloz may not have to do anything to put a lid on the Canadian dollar if a widely expected U.S. rate hike or another drop in oil prices comes to pass, noted William Adams, senior international economist at PNC Financial Services Group.
The bank raised growth forecasts for 2016 but nudged them lower in 2017, saying that while the United States, Canada’s largest trading partner, would regain momentum after economic weakness early in 2016, the recovery’s profile and composition would be “less favorable for Canadian exports.”
“They accentuated almost every negative they could,” said Doug Porter, chief economist at BMO Capital Markets.
Still, the bank said the output gap - the difference between its estimate of the economy’s capacity and how much is actually being used - could close earlier than previously expected, likely in the second half of 2017 rather than at the end of 2017.
Additional reporting by Matt Scuffham in Toronto; Editing by Jonathan Oatis and Leslie Adler