“The recent surge in the Canadian dollar is unlikely to crimp Canada’s economic recovery. Similarly, the weak US dollar is a sign of an improving US economy and is also not hurting Canada’s economic recovery. Finally, the Bank of Canada’s latest projections has the Canadian economy recovering by a robust 6.5% this year and 3.7% In 2022.”   

The Canadian dollar recently traded as high as 83 cents the US as the combination of improving commodity prices and recent statements by the Bank of Canada on a possible timeline for future interest rate increases sound more hawkish than Fed statements. 

Indeed, the Bank of Canada recently reduced the pace of its purchases of government debt partly because Canada’s economic outlook improved due to the government’s rather successful pace of the vaccine rollout.

In fact, the Canadian dollar is outperforming all of its peers this year, and several analysts see room for more gains as the economic recovery picks up, bolstering some mutterings on the need to reduce the hefty Canadian government stimulus payments.

While the impact of a rising Canadian dollar on Canada’s exports has historically been seen as an economic headwind, in the current unusual circumstances (strong commodity prices, somewhat stronger oil prices, improving growth in the US economy), the strengthening Canadian dollar is simply a recognition of confidence in Canada’s ability to recover from the pandemic downturn.

The broad consensus among economists is that the recent surge in the loonie and the increased consumer costs are unlikely to shake that underlying urge of Canadians to spend their accumulated savings after the long drought associated with the pandemic.

Thus, a strengthening Canadian dollar should not prevent Canada’s economy from continuing on a fairly strong recovery trajectory. 

As the following chart illustrates, $1 Canadian dollar was worth 83 cents on May 18^th while one year earlier the Canadian dollar was worth only 72 cents in the US. In other words, this represented a huge increase in the Canadian dollar relative to the US dollar.

Another way of considering the same pattern, the Canadian dollar traded at around a 6-year high of 1.23 per USD as of the third week of May. 

The Canadian Dollar Expressed In US Dollar Terms

Of course part of what is also going on is that the US dollar has been depreciating on a trade-weighted basis for quite a while. 

As the following chart illustrates, the nominal exchange rate value of the US dollar, in trade-weighted terms, is currently 30% below its level when the Bretton Woods system was abandoned in the early 1970s, and the dollar has dropped by 50% since 1985. 

Ironically, in the current pandemic environment, the recent weakness in the US dollar is not only signaling a global economic recovery but a global recovery likely led by the US.

Since the end of March, the US dollar has declined on the belief that low US interest rates will be maintained for a while yet even as many economies begin to recover more quickly from the pandemic. Fed also seems slow in planning to recalibrate its monetary policy. 

Finally, the Bank of Canada’s latest forecast has the Canadian economy rebounding 6.5% this year after the huge 5.4% decline in 2020. 

As in the US, the bulk of Canada’s decline last year was in the first quarter. As the following projections indicate, next year’s projected 3.7% growth is still unusually high and continues to reflect momentum coming out of the pandemic. 

With Canada’s “theoretical” potential GDP growth averaging around 2% per annum, the BoC’s latest projections do not suggest any major constraint due to the recent high level of the Canadian dollar.