TORONTO • Canada’s economy is being threatened by “currency instability” as the loonie’s rapid decline against the U.S. dollar is hurting business and consumer confidence, economists warn.
The loonie fell last week below 70 cents against the U.S. dollar for the first time since 2003, with the currency trading at just under 69 cents on Monday. It has fallen 33 per cent against the greenback in the past 24 months, a pace that National Bank of Canada’s chief economist, Stéfane Marion, notes is “without precedent.”
The Bank of Canada is likely to address the loonie’s collapse when it holds its interest rate announcement Wednesday.
“Currency instability has become a concern, and we think the Bank of Canada must take note,” said Marion. “For Canadian businesses, currency depreciation has already sent the price of machinery and equipment (73 per cent of which is imported) to a new record high.”
The loonie was last at parity with the U.S. dollar in early 2013. While parity was a boon for consumers, particularly those who bought goods or travelled south of the border, it hurt manufacturers who saw sales decline as their goods became more expensive to sell to international buyers.
While those same manufacturers welcomed a lower loonie, the speed of the recent plunge has unsettled some businesses. Marion said that by his team’s calculations, the loonie should have shed about 10 cents against the U.S. dollar in the past few months. But it has instead fallen by 25 cents.
“A volatile currency is every bit as harmful to planning as volatile inflation,” said Douglas Porter, chief economist of BMO Capital Markets. “I’ve always found it interesting that the Bank of Canada is so concerned about keeping inflation stable to help businesses and consumers plan and yet it’s almost as if the currency is a complete afterthought.”
The loonie’s rapid drop has been exacerbated by crumbling oil prices and monetary divergence, as a strong American labour market and solid economic growth led the U.S. Federal Reserve to increase interest rates in December. The Bank of Canada, meanwhile, lowered its rate from one per cent at the beginning of 2015 to 0.5 per cent by the end of the year.
The market is currently pricing in a roughly even chance that the Bank of Canada will cut interest rates further to 0.25 per cent next week. While Porter recently made a call that the bank would cut rates at the meeting, he noted Monday that the loonie’s collapse could be the one reason that would keep the bank on the sidelines this week.
Marion said that in order to help create some stability for the loonie, the Bank of Canada should not cut interest rates this week. Doing so would risk sending the currency as low as 66 cents in the near-term, he said.
That would bring the loonie within a stone’s throw of its lowest rate to date against the U.S. dollar of 62.70 cents, a mark achieved in 2002 when Jean Chrétien was Prime Minister and David Dodge was Bank of Canada governor.
“In our view, the Bank of Canada would be better to keep its powder dry this month and act, if need be, after the next federal budget when it will be better able to assess fiscal support to the economy,” Marion said.
While the loonie’s rapid decline is unsettling, Peter Hall, chief economist of Export Development Canada, sees no reason for the Bank of Canada to act because of it. He notes that any negative effects on business confidence are likely temporary.
He also said the export advantages of a low loonie take years to fully filter into the economy, and those advantages will start showing themselves in the upcoming year, helping ease any currency worries.
“The impact of a lower Canadian currency aren’t felt right away,” he said in an interview. “But when companies become convinced that this is more or less a permanent thing — that they can count on the Canadian dollar much lower than parity —then they’ll start to invest based on that.”
“From the moment the currency started tumbling in 2014, we’ve seen some investing coming on stream, but it takes time,” he added. “We think that’s going to be a 2016 story — companies taking advantage of the currency advantage that we have.”