Canada's Catch 22: Surging Loonie Risks Stalling Nascent Rebound

The Bank of Canada may be forced to throw cold water on a rally in the Canadian dollar that’s threatening to derail the country’s economic growth.

The central bank’s interest-rate decision this week will need to factor in a currency that’s gained the most among developed nations since policy makers helped get the rally going at their Jan. 20 meeting by refraining from cutting their benchmark rate. At the time, Governor Stephen Poloz said he was reluctant to provide more stimulus in part because a weak currency was already helping the economy.

"The Bank of Canada rhetoric may need to be tweaked going forward to allow the currency to go back weaker," said Daniel Tenengauzer, head of global foreign-Exchange strategy in New York at Royal Bank of Canada. "If you stated the currency was attractive and weak and competitive, and you appreciate by 10 percent, then you’re not as competitive any more."

With prices for crude oil, until last year Canada’s largest export, hovering near a 13-year low, the central bank is counting on non-commodity exports to pick up the slack and has said it expects a weaker currency to help by making the country’s goods more competitive abroad. With signs of that shift only starting to appear, the Canadian dollar’s recent gains are an unwelcome development.

From a 13-year low of C$1.4690 per U.S. dollar on Jan. 20, the Canadian dollar has strengthened to C$1.3317 March 4 in Toronto. One loonie, as the Canadian dollar is called for the image of the aquatic bird on the C$1 coin, buys about 75 U.S. cents.

Rival Nations

Even after the currency’s recent rebound it remains weaker than its 10-year average against its U.S. counterpart. While the level against the greenback may help the economy, its price versus the currencies of its main export competition for the U.S. market, such as Mexico, China or Europe, suggest it’s still too strong to give Canada the export boost it needs, said Greg Anderson, global head of foreign-exchange strategy in New York at Bank of Montreal.

Against the peso, the loonie is near its strongest in almost four years, while since Jan. 20 it’s risen 7 percent against both the Chinese yuan and the euro.

"It’s a huge appreciation over the last month," Anderson said. "The issue is, ‘How are you going to attract industries if, as much as the Canadian dollar cheapens, the Mexican peso cheapens the same amount?’"

Canada’s economy is projected to grow 1.5 percent this year after contracting during the first and second quarters last year. The nation probably added 10,000 jobs last month after losing 5,700 in January, according to a Bloomberg survey of economists before the March 11 Statistics Canada report.

The central bank has held its benchmark interest rate at 0.5 percent since July, following two 0.25 percentage point reductions last year. Seven of 19 economists in a Bloomberg survey predict the central bank will lower borrowing costs in 2016, with the rest forecasting no change.

Central Bank

Loonie bulls took their rally cue from the Jan. 20 BOC statement. With the currency then in free fall, the central bank cited concern it could weaken too far, too fast and damage economic confidence as one reason to leave rates unchanged. The bulls have since pushed the currency to a nearly three-month high, forcing those betting against it into their fastest retreat since July 2014.

Net futures positions held by hedge funds and other large speculators for the Canadian dollar to fall against its U.S. peer fell by more than 35,000 contracts the past five weeks, according to data from the Washington-based Commodity Futures Trading Commission.

The median forecast among currency strategists surveyed by Bloomberg calls for the currency to weaken to C$1.38 per U.S. dollar by mid-year, and end 2016 still weaker at C$1.36 per U.S. dollar.

With the shorts beaten back and the currency stabilized, worries about a panic are no longer a rationale for refraining from easier monetary policy, and the currency’s strength may be a reason for the opposite insofar as it may threaten the economy’s recovery, Anderson said.

"It was a great trade and they’ve done well over the last month, but you have to be careful," Bank of Montreal’s Anderson said. "Push it too far and you sow the seeds of your own demise."

To contact the reporter on this story: Ari Altstedter in Toronto at aaltstedter@bloomberg.net. To contact the editors responsible for this story: Boris Korby at bkorby1@bloomberg.net, Paul Cox, Mark Tannenbaum

By: Ari Altstedter

©2016 Bloomberg News