Canada’s central bank should opt for currency intervention

Canada’s central bank should opt for currency intervention

10-27-2009 14:14

Canada’s central bank, Banque du Canada, should opt for currency intervention to stabilize the rate of the Canadian Dollar in order to prevent that Canada’s manufacturing market hollows out, according to Avery Shenfeld, senior economist at CIBC World Markets Inc. “Business plant and equipment may be reduced by a strong Canadian Dollar if it’s overvalued during a number of years,” Shenfeld commented.

Currency intervention

The senior economist stated that speculators have created an overvalued Loonie that exceeds its fundamentally driven levels, as the Bank of Canada could decrease the number of speculative investments by a currency intervention. He continued by saying: “Canada may think about a ‘bounded float’. The central bank could use a currency intervention to discourage Forex trading that drive the Loonie, in its well thought-out opinion, above its economic fundamentals.”

Excessive instability

The last currency intervention by the Canadian central bank was in 1998. Several investors and economists don’t favor a currency intervention as it disturbs the free market mechanism. Currency interventions should only be used in case of ‘excessive’ instability.

Hot money flows

The current situation may be considered as excessive as the strong Canadian Dollar could lead to a further erosion of the country's manufacturing base, according to Shenfeld.
“The performance by the Loonie during the last 15 years proves that foreign exchange markets operate completely rational and calculated,” the CIBC economist stated. “Obviously, the Forex market consists of more than commodity rates and trade flows, as it also relates to extremely variable expectations as well as funds that flow into Canada to profit from a favorable interest rate, the so called ‘hot money flows’, which have a strong influence on currency movements. Canada’s central bank implies the same by indicating the negative effects of the recent strength of the Loonie.”

Canada’s central bank

The Bank of Canada stated last week that the strong Canadian Dollar would disturb positive economic developments and frustrate the 2% inflation target. Recently, the central bank of Switzerland intervened in order to prevent a strong appreciation of the Swiss Franc versus the Single Currency, as the People's Bank of China did the same, which resulted in a sluggish and solid rise of its currency, according to Shenfeld.
He continued by saying: “Intervention is an influential instrument for regulators that utilize it.” Nevertheless, Shenfeld doesn’t opt for a fixed exchange rate, which would lead to a link with the interest rate policy of the United States Fed.