The Bank of Canada shouldn’t pay too much attention to currency moves in setting monetary policy because it’s too hard to divine the significance of exchange rate shifts, says the the C.D. Howe Institute.

“The Bank of Canada should make price pressures in the Canadian economy, and hints in current data on output, demand, money and credit about where those pressures are going in the future, its main guides in setting interest rates to hit its 2% inflation target,” the think tank says in a research note.

It is often not clear what currency moves really mean, the institute says.

“Does the dollar’s decline since the turn of the year foreshadow a stronger net export performance and higher output — and perhaps an offsetting hike in the overnight rate? Or is it a signal that Canada’s part of the North American economy is flagging, and thus a signal that an overnight-rate cut is in order?” it asks.

The paper argues that “because we cannot confidently answer that question”, the Bank should stick to the other data in setting rates.

“Sorting out the reasons for a given move in the exchange rate can be difficult even with hindsight, and doing it at the six-week intervals over which the Bank of Canada sets its policy interest rate is harder yet,” it notes.

http://www.cdhowe.org/pdf/ebrief_16.pdf