October 20, 2016 / 9:02 PM / in a year

Bank of Canada's talk, not action, keeps lid on C$

OTTAWA, Oct 20 (Reuters) - Canada’s central bank head whipsawed markets on Wednesday when he mused about considering a rate cut shortly after holding rates steady. But the element of surprise is one of the few tools left to move the currency where the bank needs it to be - a little weaker to help Canadian exports.

Governor Stephen Poloz’s revelation that the central bank had “actively discussed” adding stimulus sent the Canadian dollar tumbling - just as he intended, according to some financial market players.

“It was shot across the bow at the currency, which is currently trading at slightly elevated levels to where it should be and where the Canadian economy needs it to be,” said Bipan Rai, director of foreign exchange strategy at CIBC Capital Markets.

Poloz has repeatedly said that he does not try to influence the level of the currency and that the best place for the exchange rate to be determined is in the market.

But there is little doubt among analysts that with export growth sluggish, the Bank of Canada prefers a weaker Canadian dollar right now.

“The Bank of Canada certainly liked the decline in the currency over the past two years, but they expected more from it,” said Adam Button, currency analyst at ForexLive in Montreal.

With official interest rates near historic lows at 0.5 percent, Poloz acknowledged Canada’s central bank has limited room to stimulate the economy by traditional means.

Economists have speculated the bank may want to keep some rate cutting room in reserve for a crisis. Lower rates could also fuel a housing market boom that some warn is reaching bubble levels in Vancouver and Toronto.

Poloz said on Wednesday he could use unconventional measures like forward guidance, asset purchases, quantitative easing and negative interest rates. Yet with the exception of forward guidance, the Bank of Canada has never used such tools and many market players think they would be reserved for dire economic times.

Given limited options, they said the easiest route is to talk about easing, and let the market partially price in a rate cut - keeping the currency at lower levels.

The currency had strengthened to a nearly four-week high ahead of Poloz’s news conference, boosted by surging prices for oil, a major Canadian export. It then plunged to a session low after Poloz’s rate cut comment.

“They want to see the currency weak, so they basically said they are actively discussing cutting rates,” said National Bank senior economist Krishen Rangasamy.

“The message was clear. What they had in mind was the Canadian dollar, and they want the Canadian dollar to be weak to support exports.”

While many market players criticized the bank for injecting volatility into trading on Wednesday, Citi North American economist Dana Peterson said nudging the markets is a delicate business.

“Certainly Poloz realizes that when the markets aren’t getting it, he does need to make it clear, like he did yesterday,” said Peterson. “This is an art and a science, it’s not going to be perfect.” (Additional reporting by Leah Schnurr in Ottawa and Fergal Smith in Toronto; Editing by Bernard Orr)

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