The global commodities boom that has lifted the powerful loonie is threatening to become Canada’s biggest weakness.

Both oil prices and the currency lost a bit of steam on Tuesday amid warnings from the Bank of Canada that the dollar threatens economic “headwinds,” and from economists that high energy prices are forcing consumers and businesses around the world to think twice about how they spend.

Bank of Canada Governor Mark Carney gave the strongest indication yet that he's uncomfortable with the loonie’s flight, even as he boosted his forecast for growth this year.

The loonie’s dip came as oil prices sustained their biggest two-day loss in 11 months, as Wall Street giant Goldman Sachs, the International Monetary Fund and the International Energy Agency (IEA) warned that anything above $100 (U.S.) a barrel would threaten the global recovery.

Even as the commodities boom further enriches western provinces like Alberta and Saskatchewan, it is squeezing consumers across the country. And it’s one major factor that’s helping to fuel the Canadian dollar’s rise, posing headaches for exporters and the central bank alike.

For policy makers, the currency’s strength is both a blessing and a curse.

A blessing in that it makes foreign-made products cheaper for Canadians, keeping a lid on inflation and allowing companies to invest in advanced machinery and equipment to retool their operations and boost their productivity. A curse, because Canada is such an export-dependent economy, and a strong dollar makes the country’s goods and services more expensive abroad.

Mr. Carney held his benchmark interest rate at 1 per cent Tuesday, balancing a stronger-than-expected domestic recovery against ongoing global threats – and warning that the loonie’s “persistent strength” could restrain the exports that he’s counting on to power the post-government stimulus phase of the rebound. Earlier Tuesday, a report from Statistics Canada showed exports took a big hit in February, causing the trade surplus to all but evaporate.

Investors took Mr. Carney’s remarks as a hint that he’s hesitant to risk sending the loonie any higher by raising interest rates, even though the bank says the slack in the economy will disappear six months earlier than it predicted at the beginning of the year. The currency, while still close to record levels, fell by 0.72 cents to 103.83 cents (U.S.).

Tuesday also brought a broader reality check in financial markets, as many questioned whether oil prices have gotten too high for the fragile global economy to sustain demand for energy, let alone all of the other things consumers and businesses are now less able to afford.

U.S. stocks fell after Alcoa Inc. – a barometer of industrial health – said its earnings were held back by higher energy costs.

Indeed, the IEA said Tuesday that “a sustained $100-plus price environment will prove incompatible with the currently expected pace of economic recovery,” a day after the IMF cut growth projections for the United States and Japan, two of the world’s biggest oil purchasers.

Goldman went so far as to warn that oil prices could be in for a “substantial” correction.

As for Canadian borrowing costs, Mr. Carney he was never likely to use Tuesday’s meeting to step off of the sidelines, particularly once it was clear the decision would fall in the middle of a federal election campaign.

Nonetheless, the central banker raised his forecast for Canadian growth in 2011, to 2.9 per cent from 2.4 per cent, and said the economy will be running at full tilt by the middle of next year. All of which means Mr. Carney knows his first increase since September needs to happen sooner than later, so he can avoid falling behind the inflation curve.

But with the loonie looming larger in his mind, the Governor is unlikely to give a clearer sense of his timeline for higher rates when he releases the full quarterly forecast paper on Wednesday.

Economists zeroed in on July 19 as the likeliest date for a rate hike, after Mr. Carney’s comments Tuesday gave precious little sense that he’ll move in late May. Among other reasons, waiting until July would allow the U.S. Federal Reserve’s bond-buying program to run its course, lessening the upward pressure on the loonie.

It may be that Mr. Carney was simply trying to talk down expectations for a May hike, giving him the flexibility to consider one without having to worry about speculators driving up the currency in the interim.

Or, more ominous, it may be the central bank genuinely worries that the sky-high loonie, a symbol of Canada’s economic success, could become the rebound’s undoing.

“If some of these risks actually do deteriorate in the months ahead, and the currency remains a going concern, it is possible they’ll delay even beyond July,” said Douglas Porter, deputy chief economist at BMO Nesbitt Burns. “The last thing the bank wants to do is send the currency flying higher.”

Article provided by The Globe and Mail

http://www.theglobeandmail.com/report-on-business/economy/interest-rates/strong-loonie-casts-shadow-over-recovery/article1981580/