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The Bank of Canada would likely react to any unwelcome further strength in the dollar by scaling back economic projections or tweaking other guidance rather than seeking to directly talk it down, Dominique Lapointe, a former economist in the finance department's forecasting branch, told MNI.
Canada's dollar could strengthen a bit further based on fundamentals such as higher prices for exported metals, minerals and lumber, he said. The chance of a major further rally is hemmed in by rising energy prices and potential Fed tightening signals, said Lapointe, now senior economist at Montreal-based Laurentian Bank Securities.
"What you would see is a larger than expected output gap, or somewhat lower inflation, and in that case that could justify changing their guidance," he said. "That's how they do it if they are really concerned about currency movement. I don't think they are ever going to resort to saying we think that the Canadian dollar is too high."
Governor Tiff Macklem told reporters Thursday the currency's strength reflects higher exported commodity prices "to some extent" and further appreciation could become a headwind to exports and investment. That statement didn't leave any clear clue on a particular level of the dollar that could be a problem for the BOC, Lapointe said.
"What they are going to say and how they are going to react is in their economic forecasts, they are going to factor in somewhat lower growth based on negative Canadian dollar impact," if needed, Lapointe said.
Canada's dollar strengthened to around six-year highs of CAD1.20 per U.S. dollar this week, from about CAD1.40 a year ago.
Part of that appreciation also comes from the BOC's move to taper QE to CAD3 billion from CAD5 billion and guidance that the conditions for raising the 0.25% policy interest rate may be in place in the second half of next year. The BOC may taper QE in two further steps at meetings in July and September, then hold the pace at CAD1 billion to keep the size of its balance sheet intact, Lapointe said.
While currency models based on economic fundamentals suggest a fair value of CAD could be CAD1.11, current conditions suggest that kind of increase is unlikely, Lapointe said. The U.S. economy is gaining strength so Canada's dollar won't be riding high on any swoon in the greenback. Supply bottlenecks may also hold back the gains in global demand that would keep driving up commodity prices.
CLOSE TO PEAK MOMENTUM
"That's how maybe they are seeing this -- as an excessive appreciation in commodity prices, affecting the dollar, that they might be concerned about," he said.
"We are at peak or close to peak economic momentum globally," Lapointe said.
So far the stronger currency has come without complaints seen in years past from Canadian manufacturers about losing sales, which takes some public pressure off the BOC to react. It's possible the stronger dollar is helping some firms buy imported products more cheaply, Lapointe said.
"I don't see it in the short term as being a problem for competitive reasons," he said.