Americas: Canadian dollar turns suddenly popular, The

Global Finance, Apr 2003 by Platt, Gordon

Rising interest rates, solid economic growth, a big trade surplus and strong commodity prices propelled the Canadian dollar sharply higher in March.

Why did the long-hapless loonie, as the Canadian currency is known, suddenly become the darling of foreign exchange traders?

"It's the difference between a glass half full and one half empty," says Stephen Poloz, chief economist at Ottawa-based Export Development Canada.

The fundamentals have been screaming for a higher Canadian dollar for a long time, so long that market participants wondered if the loonie was ever going to rise, he says.

"Exchange-rate moves are a lot like earthquakes," according to Poloz. "We know the fundamentals, and forecasters predict that exchange rates will react to them, yet nothing happens, sometimes for years.Then some trigger produces a sudden burst of action," he says.

Exchange rates typically overshoot their fundamentals, he adds. Once the exchange rate begins to move, foreign exchange traders begin to place bets that it will move further; the further it moves, the further it is believed likely to move, and so on.

The rising Canadian dollar could pose a problem for some Canadian exporters, particularly if they have been barely eking out a profit and have been relying on the low level of the loonie to compete for business. But Poloz says most Canadian companies have been expecting a stronger currency for some time.As the world economy heals, Canada's export sales increase, boosting profit margins at exporting companies, he says.

Canadian finance minister John Manley said in early March that he was not concerned by his nation's currency appreciation. It should be left to the markets alone to decide its appropriate level, he said.

Marc Chandler, chief currency strategist at HSBC Bank USA in New York, says Canada is likely to be the fastest-growing economy in the Group of 7 industrial nations in 2003. In February, as the United States was losing more than 300,000 jobs, Canada added 55,200 jobs, he notes.And the Bank of Canada is expected to raise interest rates further in the second quarter, he adds.

According to Chandler, the widening interest-rate spread between the US and Canada, especially at the short end of the yield curve, is consistent with a stronger Canadian dollar. The trajectory of the policy mix in Canada toward a tighter monetary policy and a looser fiscal policy is usually associated with an appreciating currency, he adds.