Canadian dollar a factor in Bank of Canada interest rate decisions

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Bank of Canada Deputy Governor Carolyn Rogers said the central bank will keep the loonie in mind when deciding whether to freeze rates or implement another hike this year.

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The Canadian dollar will not be the central bank’s main focus. That will be inflation, which Rogers reiterated remains far too high. However, she acknowledged that a weaker dollar could complicate the Bank of Canada’s attempt to contain price pressures.

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“We’re not targeting the Canadian dollar,” Rogers told reporters March 9 after a speech in Winnipeg hosted by the Manitoba Chamber of Commerce. “Of course, we will keep an eye on the Canadian dollar in case the dollar depreciates against other currencies, particularly the US dollar. The US is one of our most important trading partners, which could potentially lead to some inflationary pressures if Canada’s import costs increase.”

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After the Bank of Canada left interest rates on hold at 4.5 percent on March 8, the Canadian dollar slipped over 1 percent against the US dollar to 72 cents on the day. This is the lowest value since October.

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That decline could continue if the Federal Reserve meets market expectations that it will hike the federal funds rate to 5.5 percent or higher. Chair Jerome Powell said this week interest rates may have to rise higher than he expected earlier in the year because of his failure to tame inflation.

Still, it’s unclear whether the Bank of Canada needs to follow the Fed. Karl Schamotta, chief markets strategist at Toronto-based financial adviser Cambridge Mercantile Corp., said the translation of a lower Canadian dollar into higher costs hasn’t been as dramatic in recent decades as people think.

“I think that’s something that most Canadians just don’t realize,” said Schamotta. “Prices in Canada are not responding to the exchange rate as quickly as they think.”

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Schamotta added that he expects the Bank of Canada to focus on domestic inflation developments rather than currency dynamics.

Bank of Nova Scotia economist Derek Holt has been one of the louder voices on Bay Street warning about the dollar. He said this week that the Bank of Canada appears less concerned about the exchange rate than in the past, noting that policymakers merely noted in the policy statement that the “US dollar has strengthened”. That means no concern.

Holt also pointed out that the statement lacked a reference to “excess demand,” the term the Bank of Canada uses when its calculations show that demand exceeds its estimate of the economy’s ability to supply goods and services without fueling inflation. He took this to mean that the central bank had become “dovish,” or less inclined to raise interest rates.

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“They suddenly think the Canadian economy has wiped out excess demand after a GDP report,” Holt said. Gone are two references in the previous statement to how the economy continues to exhibit excess demand. If that’s an accident then it’s two pretty big ones and not something I believe in.”

Statistics Canada reported last week that gross domestic product faltered in the fourth quarter.

Holt wasn’t the only Bay Street analyst to point out the lack of a reference to “excess demand” in the new policy statement. But those who took the omission as an indication that the Bank of Canada had moderated inflation may have misinterpreted the central bank’s message.

“The economy is still in excess demand,” Rogers said at the news conference. “So we still have a long way to go to find the balance we’re looking for.”

• Email: shughes@postmedia.com | Twitter: StephHughes95