Dollar's climb has Bank of Canada wary

The loonie's recent spike has the Bank of Canada nervous, and some economists see a return to parity with the U.S. dollaron the horizon.

Amidits latest pronouncementon interest rates, Canada's central bank warned that the loonie's rapid rise up from 79 cents US on April 1 to over 90 cents US in early June could hurtconsumer and business confidence, whichit said had recently "recovered modestly."

"If the unprecedentedly rapid rise in the Canadian dollar (which reflects a combination of higher commodity prices and generalized weakness in the U.S. currency) proves persistent, it could fully offset these positive factors," the bank said.

A higher loonie makes imported goods cheaper for Canadian consumers and businesses, but at the same time makes Canadian exports more expensive for U.S. customers.

The U.S. dollar has experienced weakness recently as investors tookthe fledgling signs of economic recovery as an opportunity to move out of the relative safety of the greenback and into more diverse positions. Perceived commodity-based currencies such as the Canadian and Australian dollars are seen as benefiting from that shift.

Some market watchers expectthe loonie to climb back to parity with the greenback for the first time since mid-July 2008.

In a new global forecast, Scotia Economics sees the Canadian dollar climbing steadily back to parity by the fourth quarter of 2010.

Well above forecast

Economist Sal Guatieri of BMO Capital Markets pointed out that the Canadian dollar is already 10 cents above the 80 cents US average on which theBank of Canada based its April economic forecast.

"While the Canadian dollar's recent rocket-ride warrants some concern a good part of the appreciation is supported by rising commodity prices, which neutralizes the adverse impact of the stronger dollar on the economy," said Guatieri.

Grant Bishop of TD Economics said the fact that the Bank of Canada hasn't used quantitative easing or credit easing to bolster the economy increases the attractiveness of the Canadian dollar.

"To the extent that the exchange rate is passed through to lower import prices, the higher Canadian dollar is a further downward pressure on inflation, but it also dampens the cost advantage of Canadian exports, a further near-term handicap to Canadas stumbling manufacturing sector," Bishop said.

Some economists, however, expect the U.S. dollar to regain some lost ground.

"Our assessment is that the Canadian dollar will likely give back some of its recent gains as the impact of the recent burst of risk appetite wanes and the U.S. dollar stages a modest recovery," said Dawn Desjardins, assistant chief economist at RBC economics research.