Loonie Rise: Canadian Dollar Will Climb Against The U.S. Greenback In The Long Run

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CANADIAN DOLLAR
The Canadian dollar may gain if the Bank of Canada raises rates later this year. | CP

TORONTO -- Like the fortunes of the Vancouver Canucks at this year’s Stanley Cup playoffs, the Canadian loonie has soared, giving NHL team owners north of the border an economic home advantage.

Since last December, the Canadian dollar has hovered near parity, closing at $1.024 on Monday and reaching $1.034 early today. It’s a steep hike from 95.8 cents U.S. a year ago and as low as 62 cents U.S. in early 2002.

"Canadian teams get their revenue in Canadian dollars, and pay their expenses in U.S. dollars," said David Watt, a senior currency strategist with RBC in Toronto. "So, in 1990, we were losing hockey teams because the Canadian dollar was so weak. Now we're thinking of bringing [the Thrashers] back [to Winnipeg] from Atlanta because the Canadian dollar makes it easier to finance a U.S. dollar operation in Canada."

However, the loonie is now under added pressure after the Bank of Canada's announcement today to hold off on interest rate hikes, despite prodding by the Organization for Economic Cooperation and Development to raise them.

The Bank of Canada will maintain its target for the overnight rate at 1 per cent, it announced Tuesday. The Bank Rate is 1.25 per cent and the deposit rate is .75 per cent.

It cited modest growth in the U.S. economy, and a European economy which is maintaining momentum, but noted risks to peripheral economies have increased. Canada also faces inflationary pressures from high energy prices and changes in provincial taxes, it added.

The Bank of Canada also said that while the possibility of greater household borrowing and spending in Canada is a risk to inflation, the continuing strength of the loonie could be an obstacle for the Canadian economy, hampering exports.

"To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be eventually withdrawn, consistent with achieving the 2 per cent inflation target," the Bank of Canada said in a statement on its website. "Such reduction would need to be carefully considered."

In its global economic outlook last week, the OECD urged the Bank of Canada to tighten monetary policy at a "moderate pace" to show that it has a grip on inflation.

After a sombre speech by Mark Carney earlier this month, many analysts had expected the Governor of the Bank of Canada to hold off on raising the target rate of 1 per cent until later in the year.

"The numbers were quite strong after the first quarter of the year, but both the U.S. and Canadian economy has slowed somewhat after the last few months. So we don't think the bank is in any rush to raise rates," said Blake Jespersen, director of foreign exchange at BMO Capital Markets in Toronto.

However, the Canadian dollar has been weakening against the U.S. dollar in recent weeks, due in part to softening data stateside. Still, Watt doesn't expect the Bank of Canada's interest rates decision to have a ripple effect on the Canadian dollar.

"I think they really just want to say as little and have as little market impact as possible … they still need to raise rates, but they're not going to rush to do it. And that's the bottom line. And that is also what is priced into the market now."

However, the Bank of Canada did want to give the market a subtle reminder that interest rates do have to rise at some point, he added.

"The way the market is priced, it was touch-and-go whether or not the market expected the interest rates to move this year, which the bank was somewhat uncomfortable with," said Watt.

The Bank of Canada's statement does not say when it will raise rates, but Watt is expecting a rate hike in the fall.

"I don't think they are going to raise rates in July, as it detailed some concerns for Q2. I don't think they are going to raise rates right away," he said.

In the long term, most analysts expect the loonie to gain even further against the U.S. dollar, despite its recent dip. RBC has pegged the Canadian dollar to reach roughly 1.05 cents between now and the end of the year, said Watt. ScotiaCapital expects the loonie to hit 1.08
cents by the end of 2011.

"The near term outlook is very important," said Camilla Sutton, Scotia Capital's chief currency strategist. "We see some recovery in the Euro, which is very encouraging, and we are seeing signs of a weakening U.S. dollar, which should imply that the Canadian dollar should be strengthening.

“As we look to the medium term, the fundamentals are still in place for a rising Canadian dollar. It's really just the near term that has created a question mark as to why it has been under-performing and how long that under-performance will last. But the fundamentals are still in place for a rising Canadian dollar."

Sutton expects the Bank of Canada to begin hiking interest rates in the fourth quarter of this year, a move that would make the Canadian dollar more attractive to investors.

Despite its strength to its American counterpart, the Canadian dollar has not held up against other currencies, including the Euro, despite the zone's well publicized debt issues.

UNDERPERFORMING LOONIE

The loonie has underperformed against many of the primary currencies, such as the U.K. Pound Sterling and the Japanese Yen, said Sutton.

The U.S., Canada’s largest trading partner, is not “firing on all cylinders”, said Watt.

"We've actually been looking at a number of indicators, which shows that the Canadian dollar, other than the U.S. dollar, has been the worst performer over the past year," said Watt. "So, the Canadian dollar strength -- I always take that with a bit of a grain of salt. Because
we're strong against the U.S. dollar, but we're not really strong against many others at the present time."

The Canadian dollar has also softened compared to the U.S. dollar in recent weeks, but the dip has levelled off, said Jespersen.

"We expect that to continue for a while," he said. "The Canadian dollar is a commodity currency, and it has weakened off with what's happened with commodities recently, but on the flip side of that is, given Canada's relatively strong fiscal position, it's been benefiting."

With the political stability of a Conservative majority government in Parliament, the Canadian dollar is expected to gain in strength, analysts predict.

EXPORT MARKET

While a soaring loonie is good news for hockey teams sitting on this side of the border, it’s making products on home soil more expensive, crimping Canadian exporting companies.

Canadian firms have learned from previous dollar surges, such as in 2002 and 2007, and are now factoring in a strong currency into their business plans, said Jespersen.

"We've already been here so companies are used to these levels. And they know how to pinch their margins at these levels ... When the Canadian dollar was quite weak, it was almost like a buffer for your business. It gave you a nice 20-per-cent margin, and you didn't need to make any productivity gains that were not too much about currency management. Now you definitely do."

To compensate, Canadian firms are increasingly importing from countries where the strong dollar allows them to get more bang for their buck, he said. They are also investing in cheaper equipment outside of Canada and trying to make their companies more efficient to
compensate for the strength of the dollar. Exporters are also targeting new markets, diversifying away from the U.S. to Europe and Asia, said Jespersen.

"Before the mentality was, 'Well, the Canadian dollar is going to stay weak for a long time, so we don't have to change our business.' And now these businesses are becoming really dynamic because there is competition coming from all over the place to make sure the business is streamlined and as professional as possible," he said.

Still, a lack of action during past loonie surges has made its strength a bigger competitive hurdle this time around, said Watt.

"When we had that strong commodity growth over 2002 and 2008, Canada really didn't make the most of it," he said. "Because we should have become much more productive and invested in machinery and equipment then, realizing the competitive challenge, that the Canadian dollar was going to go from a competitive aid to a competitive hurdle."

Canadian consumers, however, continue to benefit from a stronger dollar that can stretch on American shopping websites or in shops just south of the border.

Lisa Witt, owner of the New England Tourism Center in Montreal, said parking lots in nearby U.S. states are filling with Canadian licence plates from Ontario and Quebec.

If the weather is pleasant this summer, she is expecting more Canadians will book hotels and shop in stores such as Walmart. "The New England states, they're definitely looking for an influx and reservations to be up this summer."

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