OTTAWA/TORONTO (Reuters) - The Bank of Canada is walking a tightrope to its next rate decision, trying to rein in a Canadian dollar that has popped higher in the wake of back-to-back rate hikes - without jawboning the currency too explicitly.
While talking down the currency risks upsetting the bank’s G20 peers, rapid appreciation of the loonie could put the brakes on the country’s economy just as it gains momentum.
The currency has risen 9 percent against the greenback this year. It jumped 2.5 cents after an unexpected Sept. 6 rate hike and bank statement that said the loonie’s appreciation reflected economic strength.
Markets took the language to mean policymakers were comfortable with a stronger Canadian dollar, even though it hurts already anemic exports. Deputy Governor Tim Lane moved to mitigate that view on Monday, saying the bank was closely watching currency strength and would take “that into account pretty strongly” in its decisions.
Lane’s words did the job, erasing nearly all of the gains the loonie made in the wake of the rate hike.
All eyes are now on Governor Stephen Poloz’s speech next Wednesday, with the market expecting him to keep the dollar in check without opening himself to charges from global peers that he’s manipulating the currency.
“The 2.5 cent (jump) is not something any central bank wants to see. They don’t ever want to wrong-foot the market in that kind of way,” said Michael Goshko, corporate risk manager at Western Union Business Solutions.
“The market will expect Poloz to clarify this concern even further, as the head of the bank.”
The September rate rise followed one at the preceding meeting in July, Canada’s first hike since 2010. Raising rates at consecutive meetings has only spurred expectations for another increase in October.
This is a trend the central bank will not want and that Poloz could help break.
The urgency conveyed by the bank’s back-to-back rate hikes suggested the bank may believe it is behind the curve on tackling inflation, said Adam Button, currency analyst at ForexLive. If it signals that concern, the currency is likely to rise further as markets price in more rate hikes.
Economic data released on Friday showed inflation ticked up in August, suggesting the bank has room to lift rates further.
Keeping a lid on the currency is important for the bank, with a stronger dollar making Canadian goods more expensive abroad. Weaker exports will dampen economic growth.
The bank is more worried about the speed of the currency’s rise than its actual level, said Hendrix Vachon, senior economist at Desjardins.
But Canada and its G20 peers have agreed not to manipulate their currencies to gain competitive ground, and the issue has cropped up in the current NAFTA renegotiations. So Poloz and his colleagues have to choose their words carefully, even if analysts say there is more scope to address the issue outside of a policy statement.
“What’s agreed amongst the (G20) club is, you don’t talk about levels. You are slightly forgiven for verbally intervening if you’ve had excessive volatility,” said Greg Anderson, global head of foreign exchange strategy at BMO Capital Markets.
Editing by Dan Grebler