PAIN ON THE HORIZON

Lacklustre Canadian economy will hurt

The loonie’s spring rally may have emboldened the bulls, but don’t expect much more from the Canadian dollar this year. Much of the loonie’s gains have come from stubbornly high inflation, which has stayed above 2% for the better part of 2014. Even the Bank of Canada has taken note of the high readings: in July, it took out a reference to “downside risks” to inflation in its rate announcement.

Naturally, currency speculators have jumped on the rally. Shorting the loonie was in vogue last year, but speculators have turned more bullish in 2014, with speculative positions firmly in positive territory this summer and at levels not seen since February 2013. The party, unfortunately, won’t last. The Bank of Canada has noted that Canadian inflation is being propped up by what it calls “temporary factors.” One of the biggest is oil prices, which have steadily rallied this year. The problem is that geopolitical fears have been a bigger driver of higher oil prices than the fundamentals. Economic growth has so far been disappointing this year, and the majority of economists, as well as institutions such as the World Bank, have trimmed their forecasts for global growth in 2014.

The other factor working against the loonie is Canada’s economy. Canadians are heavily indebted, as are the provincial and federal governments, meaning they have little wiggle room to boost spending to keep economic growth going. Canada needs its businesses, which are sitting on sizable cash piles saved up in the years since the financial crisis, to do the spending. But a stronger loonie would undermine that.

“Stronger exports and business investment are essential in an environment where consumers and governments are more frugal,” note economists at Desjardins Capital Markets. “To facilitate these adjustments, the loonie cannot move up much higher to prevent hindering Canadian businesses already struggling with international competition.”

Even if temporary factors do push the loonie higher in the near term, ultimately, too many factors are working against it staying that way. —