Bank of Canada's enviable problems include sunken loonie and threat of inflation: Don Pittis

Inan upside-down world it suddenly seems as if Canada's problems have become advantages.

The country's commodities economy has been hit hard by crashing prices. Itscurrency has beenplunging. Now a tightening job market and surging GDP seem to signal that inflation could bearound the corner.

In another era those would have seemed like nothing butheadaches for Bank of Canada governorStephen Poloz, but ashe makes his monetary policy statement on Wednesday, other central bankers onlywish they had hisproblems.

• Negative interest rates an option in Canada, Stephen Poloz says
• Startling Canadian GDP numbers could signal economic turning point

Just four months ago Stephen Poloz surprised the world by saying the Bank of Canada was contemplating negative interest rates. As that experiment turns sour elsewhere, Polozmust be positively thrilled the plannever got off the drawingboard.

The loonie advantage

And the reason Polozdidn't haveto break out thatuntried secret weaponhas a lot to do with characteristics of the Canadian economy thatwould in other timeshave been considered deficiencies.

Being a medium-sized resource-dependent country without access to one of the world's great currency blocsonce seemed a problem. For parts of the economy it definitely was.

As it's not part of abigger currency bloc, the loonieis easily pushed up and down by trade flows. But now, rather than being trapped in a currency blocwith moneythat is inappropriately valued,as areEurozone membersGreece and Finland, Canada is feeling the benefits of something that once seemed like a curse.

Economy-eating disease

One of the great retrospective triumphs of outgoing New Democratic Party leader Thomas Mulcair was his identification of Dutch disease as eating away at Canada's non-resource economy.The problem was that identifying it did not mean there was anything anyone could do about it.

As foreign currencyflooded into Canada to buy our resources it first had tobe converted intoCanadian dollars, pushing the loonieabove the value of the U.S. greenback.

Now, while everyone else in the world tries to manipulate their currencies to drive them down, crashing resource prices have already done the job for the loonie. The Bank of Canada didn't have to lifta finger.

This week's G20 meeting is expected to include ascolding for countries who have tried to beggar their neighbours by cutting interest rates and makingtheir exports cheaper.Canada's Polozis beyond reproach becausereverse Dutch diseasehas done the job for him.

Fewer Zombies

For the same reason Canada has fewerzombie companieskept alive by artificially low interest rates. Canada's weakest non-resource operations were clubbed into submission years ago by the high loonie.

And while so much of the rest of the world suffers from the uglyand dangerous effects of deflation, new signs of aCanadianeconomic rebound and renewed labour demand may actually hint that inflation could be on the way.

At this week's meeting of the International Monetary Fund, held in conjunction with the G20in Washington, Polozand Finance Minister Bill Morneaushould eachearna gold star from IMF chief Christine Lagarde. She likes stimulus and inflation and she wants to see more of it.

Theknock-down drag-out fight between those who favour and those whooppose the negative interest rates strategy will continue at the meeting. Butthere are a growing number of voices who worry it is dangerous and destabilizing to the world economy. Like quantitative easing before it, negative rates are showing no clear signs of havinghelped the broader economy.

Early indications from Japan are that it has not had the expected effect of making the currency more competitive. Demonstrating how little these economic tinkerers understandwhat they are doing, negative rates have unexpectedly driven theyen and theeurohigher.

So how does this affect what Poloz will tell us on Wednesday?

Inflation bullseye

As everyone has said so far, despite strong growth and jobs and the prospect of federal government stimulus spending,there are no expectations that the Bank of Canadawill change interest ratesthis time round.

In the longer term, however, Poloz, so long focused on interest rate cuts,may find himself contemplatinga rateincrease. If inflation rises much above twoper cent, under current Bank of Canadarules his hands will be tied.

As the bank has said in the past, the inflation target could be adjusted up a touch, or, for example, made discretionary up to say, four per cent. While such a move would not force the consumer price indexto rise, it could have a psychological effect, increasinginflation expections for both prices and wages..

Such a decision could only be made after agreement by the federal government. But at tomorrow's meeting watch for a firm statement ruling out a change in the inflation target, or a sign thatthe door has been left open a crack.

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