E When It Comes To The Canadian Dollar The Bank Of Canada Is Caught Between A Rock And A Hard Place

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Figure 2 Canada's Current Account Balance

Foreign investors sought out Canadian assets in record amounts last year. They acquired a record C$80.5 billion of Canadian debt securities in the second quarter of 2020, almost twice as high as the previous record of $46.3 billion set in the third quarter of 2017. Foreign investors continue to favor Canadian government debt, given its triple-A rating.  Also, overseas buyers purchased Canadian private corporate bonds placed in both Canadian dollars and foreign currencies. Canada continues to record net inflows of foreign portfolio investment (Figure 3).

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Figure 3 Foreign Portfolio Investment in Canada

So far, the rise in the Canadian dollar has not materially affected the current and capital accounts, even during one of the most tumultuous years in living memory. But the Bank of Canada now acknowledges that the Canadian dollar is “becoming its own source of drag,” according to Macklem. He goes on to explain that:

 “As we make our projections of the Canadian economy, it’s beginning to become a material factor. It’s on our radar screen. In our press releases, we highlight things that are material, that are on our radar screen, and that’s why you’ve seen it in the last couple of press releases.”

Benjamin Tal of the CIBC argues that the Canadian dollar has “no business” at the current level of 79 cents. That is, the trade account fundamentals do not support the current exchange rate (exchange rate too high). Lowering the bank rate has the potential of encouraging foreign investors to sell Canadian dollars and seek higher returns in other currencies. However, The Bank of Canada has consistently resisted lowering the bank rate, currently at 0.25%. Yet, Canada has the highest bank policy rate among industrialized nations and thus has room to cut that rate further. The Bank fears going down the road towards negative interest rates. So, the Bank of Canada is somewhat stuck at this stage of the business cycle, unable to get any real stimulus from cutting rates further, yet deeply concerned that a rising currency only makes the recovery all that more difficult.

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William K. 1 month ago Member's comment

Very interesting and educational. Thanks for the post.

Norman Mogil 1 month ago Author's comment

My pleasure

Arthur Donner 1 month ago Contributor's comment

nice article Norm

The C$ certainly is too strong for the Canadian economy at this time.

But as you point out, its strength is really the mirror image of the US dollar weakness.

The Fed also does not target its currency.