Canada’s Murray Says Currency Markets are Operating Soundly

Bank of Canada Deputy Governor John Murray said that even though currencies and other assets have periods where they overshoot fundamental values, the relationship between exchange rates and retail prices is working as it should.

“As with any asset price, bouts of temporary overshooting and excess volatility are common,” Murray said in a speech at Mount Allison University in Sackville, New Brunswick. “However, the broad trends and behavior of these markets are more positive than many believe and earlier evidence might indicate.”

Murray’s speech, “Price Puzzles and the Exchange Rate,” focused on price gaps between similar goods in Canada and the U.S. and didn’t touch on the central bank’s policy interest rate or the Canadian dollar’s current value.

Finance Minister Jim Flaherty has criticized Canadian retailers for prices on some items that are higher than in the U.S. at a time when Canada’s dollar trades for close to parity, and he has asked some companies for ways to close the gap.

Canada’s dollar is down about 5 percent this year versus the U.S. dollar, poised for its biggest annual decline since 2008. The central bank last month dropped a bias to raise a policy interest rate because of slack in the economy including sluggish exports and business investment.

The Canadian currency depreciated 0.4 percent to C$1.0461 in Toronto today. One Canadian dollar buys 95.63 U.S. cents.

Governor Stephen Poloz and Senior Deputy Governor Tiff Macklem will testify tomorrow to the Senate’s banking committee at 4:15 p.m. in Ottawa.

Pronounced Gaps

Although aggregate prices in Canada have been lower than in the U.S. for much of the past three decades, “things have changed in the past 10 years,” Murray said, adding the Canada-U.S. exchange rate, rather than acting as a buffer for price gaps between the two countries, seems to be making them more pronounced.

Intervening in currency markets to bring down the cost of local goods would be counterproductive, Murray said, because depreciating the exchange rate would drive inflation higher, leading to increased prices. The exchange rate is driven by “fundamental determinants” such as commodity prices and interest rate differentials that can’t be suppressed forever, the deputy governor said.

Evidence from recent studies at the Ottawa-based bank suggests exchange rates and aggregate prices are moving in the right direction and broad trends are “positive,” Murray said.

The Bank of Canada will stay focused on its inflation mandate, Murray told the audience after his speech. Although the central bank closely monitors exchange rates, it doesn’t target them, and the currency’s level is only one variable in making decisions in interest rates, he said.

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