Last year, the Bank of Canada implemented two quarter point interest rate increases in the second half of the year to lift Canada’s benchmark Bank Rate to one percent. Since then, Governor Mark Carney has said on several occasions that further rate hikes are necessary to head off inflation as the economy recovers. More recently however, the Governor appears to have softened his stance on the need for a rate hike and most observers feel tomorrow’s scheduled rate announcement will maintain the status quo until at least the next interest rate review meeting.
According to Statistics Canada, the Canadian economy recorded its fourth straight month of growth in January. Gross Domestic Product (GDP) expanded by 0.5 percent for the month for an annualized gain of 3.3 percent from the same time a year ago. The gains were realized largely by renewed strength in the manufacturing and transportation sectors while a jump in demand for commodities helped push global prices higher. As a leading exporter of oil, copper, and other resources, the Canadian economy was well-positioned to gain.
The Canadian dollar – known as the “loonie†because of the waterfowl featured on the reverse side of one dollar coin – has also benefitted from the country’s recent growth. In the past six months the loonie has gained nearly eight percent on its U.S. counterpart and by mid-day today, one Canadian dollar could buy US$1.0466.
Canada, like all the industrialized economies, has seen an increase in inflation driven largely by the recent run-up in oil prices. The trickle down effect of higher energy costs is an across-the-board increase in everything from food, to utilities, to clothing. However, when you remove the volatility brought on by higher energy costs, inflation is still within the two percent target range the Bank strives to maintain.
There is a worry that the surging loonie could force the cost of Canada’s exports too high for holders of weaker currencies. Again, with the U.S. buying such a large share of Canada’s goods, the fact that the loonie is leaving the greenback in the dust right now, is a real concern and this is one factor the Bank is obviously taking into consideration.
That’s because hiking interest rates to deal with inflation will make demand for Canada’s currency even greater. Investors naturally seek opportunities with the best combination of safety of funds and potential for yield. The challenge for Carney and the Bank of Canada is to strike the right balance that keeps inflation in check without the unintended consequence of forcing the currency higher and potentially harming export sales.
