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Bank of Canada in bind as loonie continues climb toward parity with U.S. dollar

OTTAWA - The Canadian dollar's apparently relentless climb back to parity with the U.S. dollar is leading to speculation that the Bank of Canada may be considering doing more than talk about the dangers of a strong loonie.

OTTAWA - The Canadian dollar's apparently relentless climb back to parity with the U.S. dollar is leading to speculation that the Bank of Canada may be considering doing more than talk about the dangers of a strong loonie.

The loonie has appreciated more than two cents in the past few trading days and many are projecting it could attain parity by the end of the year. It closed at 92.64 cents U.S. on Tuesday, after briefly hitting 93.44.

While that may sound good to snowbirds contemplating a trip south in a few months, bank governor Mark Carney has warned such a move puts the strength of the economic recovery in jeopardy.

Avrim Lazar of the Forest Products Association of Canada estimated for each penny rise in the loonie's value, the battered pulp industry loses 15 per cent in returns.

"We export more than two-thirds of what we make, so any sign of recovery will be undermined by the dollar going up," he said.

"Mr. Carney is right to be concerned and he's right to look at all tools at his disposal."

Most observers fully expect Carney to once again hector about the dollar's inflated value at Thursday's policy announcement, and leave it that.

"The Bank of Canada has a great opportunity. If U.S. weakness continues, the Canadian dollar might actually underperform other currencies waiting for what the bank might say," Scotiabank currency analyst Camilla Sutton said.

However, economists caution the central bank risks losing credibility if it keeps warning about action, without following through. Few think Carney should intervene or will intervene at this point.

The 11-member C.D. Howe Institute's 11-member monetary policy council said Tuesday the bank should restrict it's statement Thursday to repeating its promise to keep the policy interest rate at 0.25 per cent until mid-2010.

"Few felt that the Bank of Canada should react in words or deeds, and several stressed that attempts to steer the exchange rate had led monetary policy badly astray in the past," the think-tank said in a statement.

The problem is that words have proved insufficient.

Carney and his deputies have issued sporadic public warnings about the strong loonie's impact on the economy since June, with only anecdotal evidence that the exhortations had the desired effect, even fleetingly.

Deputy governor Timothy Lane issued the sternest warning two weeks ago, going beyond stressing the dangers to the economic recovery posed by a strong loonie, to suggesting that the bank "retains considerable flexibility," including so-called quantitative easing, to ground the bird.

UBS Securities Canada chief economist George Vasic said he understands why Carney would want to talk the loonie down since the bank's calculus likely considers the "fair value" for the currency under current commodity prices at about 85 cents.

But Vasic says in the longer term a weak Canadian dollar is not welcome.

"The only reason the dollar will stay strong is if economic conditions stay strong," he explained. "The dollar is a reflection of these conditions, so if we went down to 80 cents, it's likely because we would have had a deflationary shock and that's good for no one."

The economist does not believe that will happen. He has updated his forecast for the economy to coincide with the central bank's, saying growth will return to a relatively strong 2.9 per cent next year.

The bank's other difficulty dealing with the dollar is that its options are limited. With the policy rate as low as it practically can go, Carney cannot reduce short-term interest rates to cool the market's appetite for the Canadian currency.

And TD economist Charmaine Buskas called the unconventional quantitative easing option, which would increase the money supply, an idle threat given that even the bank believes the economy is bouncing back.

"This will not stop the Bank of Canada from reiterating its 'considerable flexibility' with regard to the conduct of monetary policy," she added.

Buskas believes the dollar would have to rise a lot further and very fast for the bank to intervene.

 
 
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