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High dollar could brake economy, Bank of Canada says

The Bank of Canada wants other large trading nations, particularly China, to adopt more flexible exchange rates to absorb the global shock that has emerged due to the rapid drop in the value of the U.S. dollar.

Canada is bearing a "disproportionate share" of the disorderly adjustment that has hit the world due to the "rapid and significant" fall of the U.S. dollar, according to notes prepared for a Wednesday morning speech by Paul Jenkins, senior deputy governor of the Bank of Canada.

Mr. Jenkins was speaking at the third annual Ontario Economic Summit in Niagara-on-the-Lake, Ont. Canada's central bank cautions that the U.S. dollar's rapid drop will create global trade imbalances. This, in turn, could spark a rise in protectionist sentiment.

The rapid rise of the loonie relative to the U.S. greenback already means the high Canadian dollar could slow Canada's economic growth, the speaking notes state: "While domestic demand in Canada remains robust, if recent levels of the Canadian dollar were to persist, the risk is that output and inflation would be significantly lower."

Other nations, particular China, need to adopt greater flexibility in their exchange rates to absorb the shock, according to the notes. He said the G-20 meetings this week in South Africa offer a chance to press other nations to move toward greater exchange rate flexibility.

Indeed, during his presentation, he said that it is imperative for China to reassess its economic strategy and make its tool more flexible to successfully manage such a large economy.

The bank has been surprised by the speed at which the loonie has risen relative to its U.S. counterpart, the notes state. The Bank is also concerned over the weakening of prospects for the U.S. economy, and the tightening of credit conditions.

There are signs of improvement, Mr. Jenkins said as he delivered the presentation. "Some of this adjustment in the real estate market in the U.S. is a welcome adjustment."

The Canadian economy is currently operating above its production capacity. Even so, the speaking notes state that while momentum in domestic demand has been strong, net exports have been exerting a significant drag on growth.

In his presenation, Mr. Jenkins said it "is a concern" that the surge in the dollar could put downward pressure on output and inflation.

Indeed, Statistics Canada reported Wednesday that its leading index of economic indicators rose a lower-than-expected 0.1% in October, following a revised gain of 0.3% in September, Statistics Canada said on Wednesday. Economists had been expected a 0.3% rise.

Financial Post 2007