WESTERN PRODUCER — Many economists expect central banks will begin winding down interest rates this summer, and that will likely affect currency exchange rates, including the Canadian dollar.
One thought circulating among economists and analysts is that because of the surprisingly strong economy in the United States, its central bank, the Federal Reserve, could remain wary of inflation and be reluctant to lower interest rates.
Economies in other countries, including Canada, are not quite so robust, meaning inflation pressure could be lower. That could result in a desire to start lowering interest rates sooner.
But if that happens, international money will flow to the higher rate in the U.S., raising the value of the U.S. buck relative to other currencies such as the loonie.
The Canadian dollar’s value versus the greenback is already at a relatively weak level.
Over the past 12 months, the loonie has ranged between US72 to 76 cents.
In 2021 and much of 2022 the Canadian dollar was in a higher range, from 77 to 83 cents, but in September 2022 the worries about inflation around the world could no longer be ignored.
The expectation was that the Federal Reserve, known simply as the Fed, would have to seriously hike interest rates to reduce inflation.
The U.S. economy was hot and expectations were that the Fed would need to be aggressive to cool growth, allow supply and demand to balance, and kill inflation.
The expectation was that the Canadian economy was not as robust and the Bank of Canada would not be able to be as aggressive in raising rates. If it did there would be a greater danger of pushing the economy into recession.
And as already noted, if rates were higher in the U.S., that would support the greenback.
Also, higher interest rates and a cooling economy would reduce demand for Canada’s commodity resources, putting more downward pressure on the loonie.
Another factor at play is the trend that whenever there is global economic uncertainly, money flows toward the safety of the U.S. dollar.
So in the fall of 2022 the loonie fell about five cents, down to 72 cents, and then stabilized in the 72 to 76 cents range we’ve seen for the past 16 months.
The Bank of Canada was almost as aggressive as the Fed, with its interest rate peaking in July 2023 at five percent and holding there. The Fed peaked in July slightly higher at 5.25 to 5.5 percent.
The Canadian dollar was edging toward 76 cents last spring but that higher U.S. rate in July caused the loonie to gradually weaken back down near 72 cents, even as crude oil prices rose to about $90 a barrel in September, a factor that often lifts the Canadian dollar.
However, even as the Fed was using interest rates to pump the brakes, the U.S. economy out-performed expectations.
In the fourth quarter of 2023 the U.S. economy grew 3.3 percent on an annualized basis, according to the government’s preliminary estimate.
Inflation had been beat down to 3.1 percent in November, but edged up to 3.4 percent in December, a major achievement, but still higher than the two percent target.
Canada’s economy, although weaker than the U.S., is nevertheless doing better than expected.
The preliminary assessment put the economy up 1.2 percent in the fourth quarter on an annualized basis.
The fact that both economies continue to grow means that inflation pressure is still a factor and so banks might be cautious about lowering rates too soon.
This is particularly so in the U.S., where the January jobs report issued last week showed hiring twice as high as expected and wages increasing. A tight job market and rising wages puts upward pressure on inflation.
Canada’s January jobs report comes out this week.
If the American economy continues to grow at a spritely pace, with the Canadian economy tagging along, the loonie’s value is likely to continue to range around the mid-70s cents.
But if Canadian growth stalls out and inflation here cools faster than in the U.S., then interest rate cuts could come sooner north of the border and the loonie could drift lower still.
What could change this?
A surprise increase in demand for oil and other commodities could help support Canada’s economy and currency, but that does not seem like a possibility.
Most energy analysts see crude prices mostly steady around the $80 per barrel mark. The World Bank thinks worldwide gross domestic product growth will be a little slower in 2024 than it was in 2023. The International Monetary Fund forecasts growth steady at the modest pace of 2023.
