After a summer respite when the Canadian dollar fell into the low 70 cents US, the loonie is again rallying, topping 78 cents US last week for the first time since January.
The dollar is benefitting from a strong economy and a good federal fiscal situation.
Bank of Canada governor David Dodge in a Sept. 20 speech said the institution was concerned that, with an economy near full capacity, inflation pressures would build and the bank would have to “reduce monetary stimulus.”
Earlier in the month the bank raised its interest rate by 25 basis points to 2.25 percent. Analysts think Dodge’s comments mean the bank will continue to be aggressive and additional hikes will come in October and December.
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Meanwhile, the recovery in the United States is less robust. The U.S. Federal Reserve, known as the Fed, did raise interest rates to 1.75 percent last week but with job creation slow and the threat of inflation reduced, analysts now think the Fed will not be as aggressive in raising interest rates as was expected.
This raises the expectation that the spread between the two countries’ rates will widen, encouraging a stronger loonie.
Some analysts expect the loonie will climb to 80 cents by year end.
A few see it going as high as 82 cents next year and Clement Gignac, chief economist with the National Bank, thinks 85 cents is possible by the end of 2005.
He argues that Canada’s economic and fiscal situation is significantly better than in the United States. Except for agriculture, Canada’s commodity sector is booming, in part driven by China’s appetite for metal, minerals and forest products.
As a net exporter of oil, high oil prices hurt the Canadian economy less than the U.S. , which must import $12 billion US worth of oil a month.
This dependence on foreign oil adds to America’s record current accounts deficit, which is largely a matter of the country importing more goods and services than it exports.
A declining U.S. currency would make American goods cheaper for international buyers, increase exports and lower the current accounts deficit.
Canada, meanwhile, has a strong current accounts surplus. Many believed last year’s rapid appreciation of the loonie would reduce demand for Canadian resources, but the economic boom in China and India means demand has not let up and most of the Canadian economy is doing well.
Canada’s fiscal situation is also better than the U.S. With so much spending on Iraq and security, Washington is running up a deficit of $25 billion this year.
Public debt has risen to 37.5 percent of gross domestic product, up from about 35 percent in 2000.
In Canada, another federal surplus is expected, despite increased health spending, and debt has fallen to 33.4 percent of GDP, down from 41 percent in 2000.
The impact of a higher loonie on farmers is lower farmgate prices for commodities priced in U.S. funds.
If the loonie strengthens to 85 cents by December 2005 from 73 cents in July 2004, that would be a 16 percent increase over about 17 months, not as spectacular a rise as last year, but still impressive.
Whereas last year’s loonie climb occurred as world grain prices were rising because of tight supplies, a rise this year would happen in the context of weaker grain prices as the market comes to terms with bumper crops in the U.S. and Europe and good crops in the former Soviet Union and Australia.
