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October 20, 2009 - Central bank warning sinks dollar
Central bank warning sinks dollar
Tavia Grant, Globe and Mail Update
The Canadian dollar tumbled almost two cents after the Bank of Canada issued its strongest warning yet that the strong currency will curb economic growth.
The currency slid to 95.27 cents (U.S.) Tuesday, its biggest one-day drop in four months, after closing Monday near a 15-month high of 97.15 cents.
The decline came after the central bank cautioned that, while near-term economic growth has been stronger than it expected, the currency's strength will “more than fully offset” any recent favourable developments. In other words, the dollar's drag on exports will outweigh positive news from the domestic sector.
“I expected them to up their rhetoric, but this was stronger than I expected,” said Sheryl King, head economist at Merrill Lynch Canada.
The dollar has soared about 8 per cent in the past three months, posing a challenge to Canadian exporters, which account for almost a third of the country's GDP. Every 1-per-cent increase in the Canadian dollar cuts manufacturing sales by about $2-billion and equates to roughly 25,000 job losses, Canadian Manufacturers & Exporters have estimated.
On the domestic side of the economy, by contrast, the real estate market is booming, retail sales are stabilizing and Canada's labour market has added jobs for two months in a row.
The central bank's focus was clearly on the currency.
“Heightened volatility and persistent strength in the Canadian dollar are working to slow growth and subdue inflation pressures,” the central bank said. “The current strength in the dollar is expected, over time, to more than fully offset the favourable developments since July.”
The comments represent “the toughest language by the Bank on the topic of Canadian dollar strength” to date, said Andrew Pyle, associate portfolio manager at ScotiaMcLeod, in a note.
The Bank of Canada repeated its expectation that interest rates will stay on hold until the middle of next year, dashing speculation that it may soon raise rates amid signs the economic is recuperating.
Signs of that recovery are still spotty. A separate Statistics Canada report Wednesday showed wholesale trade tumbled 1.4 per cent in August, far more than expected, amid lower sales of auto products and machinery. Weak trade likely dragged down Canada's gross domestic product for August, economists said.
The Bank of Canada's comments show “the Canadian dollar is no longer viewed as merely a risk to growth, but now as an impediment, too,” said Eric Lascelles, chief economics and rates strategist at TD Securities.
The central bank gave no sign it would intervene in currency markets to counter the loonie's rise, nor did it explicitly say the dollar is overvalued.
Still, if one reads between the lines, “the fact that the Canadian dollar will more than offset recent economic improvements suggests the bank believes the currency's appreciation is overdone,” Mr. Lascelles said.
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