Up-Down Look for Canadian Dollar

By Stein, Jon | Modern Trader, February 1989 | Go to article overview

Up-Down Look for Canadian Dollar


Stein, Jon, Modern Trader


Up-down look for Canadian dollar

For a nation that has been used to taking economic cues from its Southern neighbor, Canada might just forge its own path this year, and the Canadian dollar may remain volatile as a result.

Those cues used to include interest rate and tax hikes. But, ironically, thanks to an independent-minded Bank of Canada governor, the Canadians may beat the Americans on both counts. The path of both the economy of Canada and the Canadian-U.S. exchange rate in 1989 will hinge on interest rate differentials with other nations and on the severity of the expected dip in the business cycle.

The consensus view for higher interest rates and the degree of slowdown may very well create an upswing for the Canadian dollar. Continued restrictiveness bolstering the currency could choke export and economic growth, and higher taxes later could pull the rug out from under it.

After the Bank of Canada raised its prime rate in late 1988, three-month government securities traded at a premium of about 250 basis points to U.S. rates. If this gap were to remain while the U.S. dollar stabilizes or strenghthens, then the U.S. dollar conceivably could strengthen against low interest rate currencies (Japan and West Germany) and weaken vs. the Canadian dollar.

Foreign exchange dealers such as Michael Bowick of Royal Bank of Canada in Toronto stress that inflation, not basis points, is the government's first concern.

There is every indication restrictiveness will continue. Canadian wage costs are higher than U.S. costs, rising an annual 6%-7% compared to a 4% U.S. rise. Because of its expansionary effect on the money supply, consumer spending also is a major variable. International bond analysts at Drexel Burnham Lambert in London see reduced consumption and investment in 1989.

Canada runs a trade surplus but also a current account deficit, allowing the strengthening Canadian dollar to appreciate without threatening price inflation. …

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