Deputy governor of the Bank of Canada Tiff Macklem explained the influence the strong Canadian dollar has had over recent monetary policy decisions in a speech delivered in Lunenburg, N.S. on Thursday.

Speaking to the Lunenburg Board of Trade, Macklem noted that since the beginning of 2003 the Canadian dollar has appreciated by about 40% relative to the U.S. dollar, and by a lesser amount against a trade-weighted basket of the currencies of our major trading partners.

“This sharp appreciation appears to be largely the result of two factors: strong foreign demand for Canadian products, especially commodities, and broad-based weakness in the U.S. dollar. That is to say, both Type One and Type Two forces have been at play,” he said.

“Global economic growth has been strong over this period. Sustained strength in the U.S. economy, combined with tremendous growth in China and other parts of Asia, has led to a surge in world demand and prices for oil and gas, metals, and other commodities that Canada exports,” Macklem noted. “In many respects, what we have been seeing since 2003 is the reverse of what happened as a result of the fallout of the Asian Crisis in the second half of the 1990s, when world growth weakened, commodity prices plunged, and the Canadian dollar dropped to a low of about US64¢.

“But this is not the whole story. Another factor driving the Canadian dollar higher since 2003 has been a broad-based weakening of the U.S. dollar. The American dollar has fallen against many currencies as a result of concerns about the large and growing U.S. current account deficit,” he added. “This situation cannot be sustained indefinitely, and investors appear to believe that a depreciation of the U.S. dollar is needed to help resolve this aspect of the ‘global imbalances’. This multilateral currency realignment also appears to be playing a role in the appreciation of the Canadian dollar.

“To the extent that the Type One appreciation is working to offset the underlying positive shock to the Canadian economy, there is less need for monetary policy to respond. But the Type Two appreciation is something that monetary policy would want to respond to in the form of a lower policy interest rate than would otherwise be the case,” Macklem noted.

“Our assessment is that most of the exchange rate appreciation since 2003 reflects strong global demand and higher commodity prices. At the same time, part of the Canadian dollar appreciation has been related to the multilateral depreciation of the U.S. dollar, and we have had to factor this Type Two force into our monetary policy decision making,” he added.