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Bank of Canada alarmed soaring loonie could strangle economic recovery

OTTAWA - Bank of Canada governor Mark Carney has raised the alarm on the surging Canadian dollar, while reiterating his conditional commitment to keep interest rates at historical lows.

OTTAWA - Bank of Canada governor Mark Carney has raised the alarm on the surging Canadian dollar, while reiterating his conditional commitment to keep interest rates at historical lows.

The central bank says the dollar's recent surge above 90 cents US has been so rapid and robust that it threatens to strangle the nascent economic recovery.

"In recent weeks, financial conditions and commodity prices have improved significantly, and consumer and business confidence have recovered modestly," the bank said.

"(But) if the unprecedentedly rapid rise in the Canadian dollar proves persistent, it could fully offset these positive factors."

The central bank ended its statement by pointing out that it has plenty of ammunition left at its disposal to influence the economy, specifically making reference to so-called quantitative easing.

Quantitative easing involves the purchase of government and possibly corporate bonds, or debt, to free up stimulative money in financial markets that will lead to increased lending and borrowing by businesses and consumers.

The measure has seldom been used because it often involves increasing the money supply, increasing inflation risks.

Bank of Nova Scotia economist Derek Holt called the bank's caution on the dollar "bold" and unusually unambiguous.

"That last sentence signals it is prepared to use any and all further powers it has at its disposal if it needs to," Holt said, although he believes it is not necessary at this point.

In April, the bank had predicted the economy would begin to grow again in the fourth quarter of this year and expand by 2.5 per cent next year. While it laid out options for quantitative and credit easing, it said it didn't believe they would be necessary.

But one of the assumptions it included in the relatively rosy projection was that the loonie would average about 80 cents US. Since, the currency has soared past the 90-cent level and remains there despite a two-cent drop Wednesday.

The dollar dipped briefly below 90 cents in Thursday trading but bounced back to 90.73 cent US at midmorning.

Economist Sal Guatieri of BMO Capital Markets also doubted that Carney's trigger finger on quantitative easing is getting itchy, partly because some of the dollar's appreciation has been justified.

"While the Canadian dollar's recent rocket-ride warrants some concern - its up a whopping 10 cents from the bank's forecast assumption - a good part of the appreciation is supported by rising commodity prices, which neutralizes the adverse impact of the stronger dollar on the economy," he said.

The central bank does cite firming commodity prices, but also notes that part of the appreciation is simply U.S. dollar weakness.

Holt said a 90-cent plus dollar is devastating for manufacturing exporters in central Canada, although many Canadians gain from a strong loonie through lower prices of imported goods.

The loonie alert came in the statement accompanying the central bank's scheduled Thursday morning announcement on interest rates, although as expected, it contained no changes.

The bank said its overnight trend-setting rate would stay at the practical low of 0.25 per cent and, unless something unforeseen occurs, will stay there until next summer.

Carney also expressed confidence the economy in Canada and the world was progressing in line with expectations he laid out last April.

The central bank said that key sectors in Canada were undergoing a major restructuring and the already "significant output gap" would continue to grow through the third quarter, which should keep downward pressure on inflation.

And it reiterated its previous call that when the recovery occurs, it will be more muted than past rebounds from recessions.

The bank was pleasantly surprised last week when Statistics Canada reported first-quarter contraction in Canada had been limited to 5.4 per cent of output, significantly better than Carney's expected 7.3 per cent retreat.

But it continues to caution that the outlook remains uncertain and overall risks to the inflation projections remain tilted slightly to the downside, adding:

"Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target."

The bank's 2.5 per cent growth projection for next year remains among the most optimistic of the regularly cited forecasts.

 
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