June 15 (Bloomberg) -- Bank of Canada Governor Mark Carney, who says a strengthening currency could choke the economic recovery, may be pressed into creating dollars and buying assets such as government bonds to offset the dollar’s rise.

A 16 percent gain for the Canadian dollar since March 9 is threatening to undermine the country’s already battered exporters. This raises the likelihood that Carney will follow the Federal Reserve, Bank of England and Swiss National Bank in pursuing so-called quantitative easing, said Nicholas Rowe, an economist at Carleton University in Ottawa.

“Every increase in the currency, other things equal like the price of oil, does increase the chances” of Carney purchasing assets with new money, said Rowe, a member of the Shadow Monetary Policy Committee at the C.D. Howe Institute, an independent research group.

Asset purchases would serve a dual purpose for the central bank: They would help cut borrowing costs for businesses and households, and weaken the currency by making short-term Canadian-dollar investments less attractive.

The difference between yields on Canadian and U.S. 1-year Treasury bills rose last week to more than 20 basis points for the first time since February, before falling today to 13 basis points. Investors can earn higher yields on Canadian assets than on U.S. assets at all maturities of three years or less.

While the bank has said since April 23 it could purchase assets if needed to boost the economy, Carney has refrained from such measures. That helped boost the dollar, which appreciated in May at the fastest monthly pace since Canada floated its currency against the U.S. dollar in 1950.

Exporters Hurting

Canada’s exporters were hurting even before the recent strengthening of the currency. Canadian shipments abroad were down 31 percent in the nine months through April, Statistics Canada said June 10. Bombardier Inc., the third-largest aircraft maker, is among Canadian companies that have fired workers, sending the jobless rate to an 11-year high of 8.4 percent.

The central bank says it looks closely at the reasons behind a movement in the currency to determine whether it poses a threat to its outlook. Since 2005, the bank has referred to “Type 1” movements -- which reflect changes in demand in the Canadian economy -- and “Type 2” movements -- which have nothing to do Canada’s economic fundamentals.

While the bank says it is likely to ignore Type 1 movements, because the effect of the movement offsets the change in demand, it may use monetary policy to counter the effect of a Type 2 movement.

Type 1, Type 2

In the June 4 interest rate announcement, the bank said the recent rise in the Canadian dollar reflects higher commodity prices -- a Type 1 factor -- and “generalized weakness in the U.S. currency,” -- a Type 2 factor. It added that the dollar’s rise, if it persisted, could offset some of the signs pointing to economic recovery.

A problem for Carney is that he can’t use the tool he would normally use to counter the stronger dollar -- lower interest rates. The bank’s key policy rate is already at the 0.25 percent, which Carney has called “the lowest-possible level.”

One option still available to the bank is to commit to keeping its rate at a record low even past June 2010, Carleton’s Rowe said. Another is to weaken the dollar by selling directly in currency markets, said Benjamin Tal, senior economist at CIBC World Markets Inc. in Toronto.

‘Rising Much Too Fast’

“The bank is very concerned about it because we are still in the midst of a very serious recession and the currency is rising much too fast,” Tal said. “You might see some sorts of hints to actual intervention in the markets.”

Canadian officials have tried to talk down their currency last week. Carney voiced his concern to reporters June 11, describing the dollar’s rise as “something that hasn’t happened in 50 years of floating exchange rates,” noting it will “have an impact that offsets some important impacts to come,” and saying “the central bank is going to take notice and we are following the situation closely.”

Finance Minister Jim Flaherty told CTV Television on June 11 he is concerned there may be a “speculative element” to the appreciation.

The comments have helped to weaken the dollar. The Canadian dollar fell the next day against all 16 of the most-traded currencies. The Canadian currency, known as the loonie, depreciated 1.1 percent today to C$1.1326 per U.S. dollar at 4:28 p.m. in Toronto trading, the weakest since May 21.

Flexible Currencies

A dilemma for Carney is how to bring down the dollar without undermining Canada’s reputation as an advocate of flexible currencies. The central bank, which has a mandate to keep inflation at 2 percent, has long promoted flexible currencies.

To be sure, other analysts, including Doug Porter of BMO Capital Markets in Toronto and Mark Chandler of RBC Capital Markets, say asset purchases are unlikely, citing the central bank’s own assessment of the economy.

While expressing concern about the rising dollar at its last rate decision on June 4, the Bank of Canada said its outlook for the economy had not changed.

“Aggregate growth, as Carney noted, hasn’t seen a significant change,” Chandler said.

To contact the reporters on this story: Theophilos Argitis in Ottawa at targitis@bloomberg.net, Alexandre Deslongchamps in Ottawa at adeslongcham@bloomberg.net.

Last Updated: June 15, 2009 16:57 EDT