Bank of Canada says flexible exchange rate crucial for inflation targeting

OTTAWA: Flexible exchange rates are a key reason for the Bank of Canada's success in hitting inflation targets and will remain an important part of the monetary policy framework, a top official said on Monday.

Deputy Governor Lawrence Schembri said the floating Canadian dollar had allowed Canada to survive tough times, in particular by limiting the damage done to the economy after the 2014 oil price shock.

Schembri, speaking to an audience in Edmonton, Alberta, did not make any reference to current interest rate policy. The bank has been on the sidelines since October, and analysts do not expect it move again this year.

The Bank of Canada, in coordination with the federal finance ministry, sets an inflation target every five years, with the latest review set to be completed in late 2021. That target has been 2% for the last 23 years, which the bank has largely achieved.

"While the inflation target gets most of the attention, our flexible exchange rate is a critical component of the framework and is necessary for its success," said Schembri.

Canada's annual inflation rate edged up to the bank's 2.0% target in April.

Although Senior Deputy Governor Carolyn Wilkins last year said the bank was open to changes such as dropping inflation targeting, Schembri indicated the bank felt the current system was working well.

"Canada's experience indicates that having a market-determined exchange rate, especially with an inflation target ... fosters financial development," he said.

One option would be to adopt policies similar to those of the U.S. Federal Reserve, which targets inflation as well as full employment. Last week the Fed consulted experts on how to best target inflation.

Schembri said Canada, a major exporter of commodities, typically saw the need for a domestic monetary policy independent of that in the United States when there were large swings in commodity prices.

"Because the United States is a net commodity importer, such movements have a large differential impact on the two countries," he said.