Sunday, January 25, 2015

Loonie takes a dive after Bank of Canada cuts interest rate

After Canada's central bank, the Bank of Canada, cut the bank rate from 1.0 percent to .75 percent, the Canadian dollar, the loonie, fell to its lowest level against the US dollar since 2011.

This morning, January 23, the loonie was still trading below 81 cents to the US dollar. The Bank of Canada rate cut caught markets by surprise as no economists had been predicting the drop at this time, although many were beginning to see a drop later in the year if economic growth remained sluggish. A statement from the bank said: “This decision is in response to the recent sharp drop in oil prices, which will be negative for growth and underlying inflation in Canada, The bank's policy action is intended to provide insurance against these risks, support the sectoral adjustment needed to strengthen investment and growth, and bring the Canadian economy back to full capacity and inflation to target within the projected horizon." The rate drop was made as both the bank and the IMF predicted lower growth in Canada in 2015. The sudden drop was no doubt part of the reason the loonie's value declined so quickly.

Many of Canada's exporting companies will benefit from the lowered value of the dollar. American companies buying from Canadian companies will find that their dollar buys more as the US dollar strengthens and the Canadian dollar is worth less. The lower loonie is a mixed blessing though as Canadian consumers will have to pay more for imported U.S. goods. The move to quantitative easing in the EU also drove down the value of the Euro. It would seem that there may be moves in many countries to cut the value of their currencies so as to improve their export positions.

 The U.S. dollar at the same time is remaining quite strong. This will be a great boon for U.S. consumers as imports will be cheap. U.S. exporters may find that there is less demand for some of their goods as they will be higher in price than those of foreign competitors. Sebastien Galy of Societe Generale said: "The Bank of Canada has taken the bull by the horn deciding to target a weaker CAD. It is a surprise so early but indicates the emphasis on adjusting the CAD for a very sharp reversal in its terms of trade gains since 2002 (oil)." While Greg Moore, of RBC Dominion Securities, did not think that the bank head, Stephen Poloz, deliberately attempted to weaken the loonie further, he admitted that Poloz did see a lower currency as an important part of the recovery. Galy expects that the loonie will reach 80 cents and perhaps even 78 cents.

Lower currency prices are not necessarily a boon for a country. The fall in value of the ruble is a disaster for Russia. While it makes exports cheaper, as the price of a main export oil tumbles and it faces economic sanctions, economic growth slows and costs of imports soar. Countries such as China reap an economic windfall as the prices of its gas and oil imports from Russia drop. The U.S. does not complain about the precipitous drop in the value of the Russian ruble. On the other hand, the US constantly complains that China continues to keep the value of its currency low to make its exports more competitive. Even last April, the US was still making noises about Chinese currency manipulation: However, the Treasury expressed concern about recent reports of Beijing's "heavy intervention" to keep the value of the currency low to gain trade advantages. A weaker yuan makes Chinese goods cheaper for Americans and makes U.S. goods more expensive for Chinese, giving an advantage to Chinese exporters. So far, there have been no complaints about the Canadian move. In the case of Canada the lower dollar will make the raw materials that are among the prime exports of Canada to the US cheaper so the move helps the U.S., but imports from China are mainly manufactured goods I would expect.

 Other exporting countries such as Australia may decide to follow the Canadian example to lower the value of their currencies to remain competitive globally and increase exports. Shares of exporters, such as West Fraser Timber Co. climbed after the rate cut and the fall of the loonie. The TSX index rose 1.8 percent after the cut as well. Some exporters price their goods in US dollars. David Garofalo, CEO of HudBay Minerals Inc. said: “For companies like ourselves that have operating costs denominated in Canadian dollars and revenues in U.S. dollars, it is a win.” For U.S. retailers close to the Canadian border who benefit from increased Canadian shopping the fall in the loonie will be a definite loss.