September 23, 2009 / 1:56 PM / in 8 years

Bank of Canada accepts short-run dollar gains

SUMMERSIDE, Prince Edward Island (Reuters) - The Bank of Canada said on Wednesday it had to accept short-run volatility in its exchange rate but warned once again that a persistently strong Canadian dollar could curb growth.

Deputy Governor David Longworth referred to comments in the central bank’s September 10 statement, “that persistent strength in the Canadian dollar remains a risk to growth and to the return of inflation to target, and that the bank retained considerable flexibility in the conduct of monetary policy at low interest rates.”

The end of his quote is shorthand for saying the bank could use credit easing or quantitative easing, in effect printing money, if the currency showed persistent strength. However, he then clarified that by noting that sharp movements would essentially be ignored in the short run.

“Volatility is very difficult to deal with in the context of exchange rates, particularly short-term volatility. As an inflation-targeting country ... we focus on the effects of exchange rate movements on inflation over time and therefore we end up basically looking through short-run volatility,” Longworth said after his speech.

“It’s only if the effects persist that they’re going to show up and have an effect on the real economy and the path of inflation. So, once you have chosen to have monetary policy independent and have your own inflation target and not tie yourself to another country, you’ve in effect made the choice that you’re going to accept some volatility.”

The bank’s latest monetary policy outlook, on July 23, was predicated on a Canadian dollar worth 87 U.S. cents, or at C$1.1494 to the U.S. dollar. The currency has been substantially stronger than that since then and is currently around C$1.0740 to the U.S. dollar, or 93.1 U.S. cents.

Longworth did not say how long the Bank of Canada would “look through” currency volatility.

Most analysts believe the bank would be reluctant to engage in quantitative or credit easing, especially now that policymakers are beginning to think about exit strategies for economic stimulus measures, but the threat is always there.

The bank’s room to maneuver is limited by the fact that its policy interest rate is effectively as low as it can go, at 0.25 percent. Longworth repeated the bank’s conditional intention to keep it there through the middle of next year but said to expect a rate increase sometime after that.

“Interest rates are low and, consistent with our projection of inflation, one would expect there would be some movement up in interest rates following the end of June 2010, but anything to do with magnitude would depend on our future inflation projection,” he said.

Longworth also repeated the central bank’s view that economic growth would be stronger in the second half of 2009 than previously forecast.

On Tuesday, the bank withdrew two of its three emergency liquidity programs for financial markets, saying there was no longer a need for them.

Longworth said there had also been a drop in demand for the third such program, the term purchase and resale agreement, which will now hold auctions bi-weekly instead of weekly.

He also said he believed the U.S. Federal Reserve had the tools to be able to reverse its extraordinary stimulus measures and to be able to control inflationary pressures.

Writing by Randall Palmer and Louise Egan; editing by Rob Wilson

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