Leaping loonie in for a fall, economists predict
For Stephen Poloz, the Canadian dollar’s recent strength on optimism about the nation’s economy is too much of a good thing.
A shift to a brighter outlook by the Bank of Canada governor in April helped propel the currency to its biggest monthly rally in almost six years against its U.S. counterpart. The problem is a weaker exchange rate is exactly what the central bank says is needed to sustain the expansion.
That’s why almost every forecaster in a Bloomberg survey is calling for the gains to come to an end. Although the loonie strengthened five per cent in April versus U.S. dollar, the median prediction is for it to weaken about four cents by midyear.
“If it gets too strong, the Bank of Canada will very quickly shift its tone again,” said Camilla Sutton, chief currency strategist at Bank of Nova Scotia in Toronto. “I think he starts to highlight the impact that will have on exports, that a sustained strengthening in the Canadian dollar will damp their export forecasts, which will damp GDP.”
The reversal may already have begun. After advancing to the strongest position since January on April 29, the loonie ended last week with its first two days of consecutive losses in three weeks, Bloomberg data show. It fell to the weakest in six years in March and, by the end of that month, had dropped 13 per cent in the previous 12 months.
The currency’s April rally, and Poloz’s optimism, came as the economy showed signs of picking up amid a rebound in the price for crude oil, Canada’s largest export.
Growth had been slowing since the middle of last year along with tumbling crude, though the last month saw data on inflation, retail sales and employment all top economists’ forecasts. While a report last week showed gross domestic product was flat in February, that was better than economists’ estimates for a 0.1 per cent contraction.
The optimism may be overdone, according to David Doyle, a strategist at Macquarie Capital Markets in Toronto. He still expects the currency to fall as low as $0.69 US in the first half of next year.
“There’s a little bit of viewing the data with some rosecoloured glasses,” Doyle said. “They’re almost looking for signs to be more optimistic.”
After the Bank of Canada unexpectedly cut its benchmark interest rate in January, Poloz brightened his tone at the April policy meeting. He increased growth forecasts for the latter half of the year, saying the worst of the oil- price decline was over.
“We expect the lower dollar to provide a stronger export environment for the average exporter, especially a manufacturer,” Poloz said in testimony before Canadian lawmakers last month. “Historically it’s been a significant net benefit.”
The Bank of Canada predicted April 15 that growth would flatline in the first three months of the year before accelerating to 1.8 per cent this quarter and 2.8 per cent in the following three months. The forecasts assumed a dollar of around $0.79 US, about three cents weaker than its current level.
Because markets have interpreted Poloz’s comments as a reason to buy the currency, that optimism may actually endanger the central bank’s outlook, said Greg Moore, a senior currency strategist at Royal Bank of Canada.
“It is a bit of a paradox,” Moore said by phone from Toronto. “I imagine they wouldn’t continue to be as optimistic on the outlook if the Canadian dollar rallied another five or 10 cents.”