Standard & Poor’s has jumped into the debate over whether a strong Canadian dollar is good for the economy.

The rating agency said in a report Wednesday that the Bank of Canada would not be justified in cutting rates to keep the dollar under control.

S&P says that some observers believe the abrupt appreciation in the currency will be too much for the economy to withstand.

“It is believed by some that Canada’s export sector in particular will be undermined by the abrupt transition to a stronger currency and the economy’s competitive position will erode… The recommendation being made by some pundits is to put the brakes on the appreciation of the Canadian dollar — and the prescription? The Bank of Canada should abandon its monetary tightening bias and cut short-term interest rates.”

It notes that the weakening of the U.S. dollar has been driven by investors, hungry for returns, and turning away from the weak U.S. equity markets and low interest rates. “Taking away the interest-rate advantage the Canadian dollar now enjoys relative to the U.S. dollar would be an easy way for the Bank of Canada to stop the appreciation of the Canadian dollar. In short, the answer to the “problem” of an appreciating Canadian dollar is the achievement of narrower Canada-U.S. interest rate spreads.”

The report says that the current level of interest rates continues to support expanding consumer durable goods purchases, construction activity, and capital spending. “Through much of the past decade, Canada has relied on its trade sector to offset weakness in the domestic economy. Improving fundamentals in the past decade including low inflation, a balanced fiscal position, and declining government debt burden, as well as improved household and business sector balance sheets and rising domestic savings, should help the domestic economy become the growth leader. In fact, this proved to be the case in the global economic slowdown in 2001 and 2002,” it says.

“Against this backdrop, Canada’s competitive position is unlikely to erode dramatically despite the significant appreciation of the Canadian dollar. Low domestic interest rates will help finance capital expansion, which will help Canada’s business sector maintain a competitive foothold. Meanwhile, the appreciation of the Canadian dollar will help lower the cost of adopting productivity-enhancing technology, of which a large portion is imported,” it says.

“The more appropriate prescription for Canadian monetary policy in the near term, assuming the North American economy continues to muddle along until moving into a higher growth track later in 2003, is for the Bank of Canada to retain its monetary tightening bias,” S&P argues.

“At some point, which now appears possible later rather than sooner, the exodus from U.S. assets is likely to slow as an improving outlook for the U.S. economy and the attraction of a cheaper U.S. dollar causes investors to build up their U.S. portfolio exposures once again. At that point, the outlook for GDP growth differentials will have more of a driving influence and Canada’s interest-rate advantage will cease to boost the fortunes of the Canadian dollar,” the report says.

“Depending on when all this plays out and how high the Canadian dollar reaches before then, by the end of 2003 we may find the Canadian dollar struggling to stay above the US70¢ level. Any pre-emptive action now by the Bank of Canada to help Canada’s export sector would be imprudent. Staying on the sidelines and taking a wait-and-see approach is a defensible position, lowering short-term interest rates is not.”