A little explanation. Every time the Canadian dollar increases vis a vis the US Dollar, everything we get from the US or priced in US dollars gets cheaper (Its a lot of what we consume). Every time prices go down, inflation goes down with it. Every time inflation goes down the Bank of Canada gets an opportunity to reduce rates. Also every increase in the US dollar makes Central Canadian exports to the US less competitive and gives the BoC another reason to reduce rates.
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Undervalued loonie set to rise, economists say
OTTAWA — The Canadian dollar is undervalued and poised to strengthen, two leading economists say.
“The loonie has ignored oil over $140 (U.S.), a telecom M&A deal go-ahead, and a Bank of Canada move from dovish to neutral,” said Avery Shenfeld, economist at CIBC World Markets. “But a likely delay in Fed tightening until post-election opens the door for a stronger Canadian dollar ahead.”
Similarly, Dale Orr, chief economist at Global Insight Canada, writes that there is no good reason for the dollar not to have followed the oil price higher.
“We conclude that appreciation of the Canadian dollar remains a response waiting to happen,” he said in a note to clients.
“With the price of oil recently being revised upwards, and the other fundamental determinants of the dollar either supporting appreciation or neutral, I believe the Canadian dollar, in the par range to the U.S. dollar, is undervalued.”
In the past few years, the relationship between the oil price and the dollar has been unshakable, until the past eight months, Mr. Orr pointed out.
“Since reaching par, the Canadian dollar has refused to follow the surging price of oil,” he said.
For a while, traders probably believed the rising oil price was a temporary spike, and so didn't bid up the loonie accordingly. But now, it's apparent that high-priced oil is more than a fleeting occurrence, Mr. Orr said. Global Insight, like other forecasters, has ratcheted up its projection for oil to average $131 a barrel this year.
Other factors that usually move the loonie don't really justify the currency's holding pattern either, Mr. Orr argued. Other commodity prices are also moving up, along with oil. And the gap between Canadian and U.S. interest rates is in Canada's favour.
Part of the reason that the loonie is treading water is because traders now favour Australia as a commodity-currency play instead of Canada, said Mr. Shenfeld. Australia looks more attractive than Canada right now because Australia has higher interest rates and is less exposed to U.S. economic weakness.
“Australia's currency gain has been all about high interest rates and capital inflows, while Canada's stagnant loonie has been held back by much lower interest rates and concerns over growth,” Mr. Shenfeld said. “Look for the Canadian dollar to recoup this lost ground in 2009, as the Aussie stalls on the end of [central bank] rate hikes, while Canada sees its central bank initiating its own tightening cycle.”
The Canadian dollar closed Monday at 98.15 cents (U.S.), up 0.11 cents on concerns about rising inflation.
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