The Bank of Canada anticipates further weakness in the U.S. dollar, and has slowed it its hikes to interest rates, Bank of Canada Governor David Dodge said today.

The strong Canadian dollar, which has risen as against the greenback, is already taking a bite out of economic growth.

However, Dodge said Canada’s interest rates remain low and will eventually have to rise.

The remarks were in the prepared text of a speech to be delivered to the Vancouver Board of Trade.

Dodge indicated that the relationship between the exchange rate, the economy, and monetary policy is complex. “To understand the effect of exchange rate movements, we need to understand why exchange rates are moving, and how these movements affect the balance between demand and supply… The challenge for the Bank is to evaluate these movements, together with other data, and set a course for monetary policy that works to keep demand and supply in balance and inflation low and stable,” he said.

He divided currency movements into two types — those driven by changes in demand for Canadian goods, and those driven by foreign demand for Canadian financial assets or Canadian demand for foreign financial assets. Dodge said both types have been part of the recent strength in the loonie. “However, their relative importance appears to have shifted… And that made it difficult to determine the appropriate monetary policy response.”

Lately, a weakening in the demand for U.S. financial assets appears to be the driving factor behind the rise in the loonie. And, that has helped push the Bank to leave rates unchanged.

“Each monetary policy decision that we make is complicated by uncertainty about the persistence of exchange rate changes and about the length of time it takes for both exchange rate and monetary policy movements to influence the economy. This has been one of the Bank’s major challenges in the recent conduct of monetary policy,” he said.

Dodge noted that Canadian interest rates remain low by historical standards, and that eventually this monetary stimulus will have to be reduced. “But as I said, the second type of exchange rate movement appears to have gained relative importance in recent months, which means that aggregate demand in Canada will be weaker than we had expected last autumn,” he explained. “By slowing the pace at which we will reduce monetary stimulus, we will continue to provide support for domestic demand to offset the additional drag we expect from net exports.”