Canadian Dollar’s Vulnerability to Rate Cuts
Economists warn that the Canadian dollar could decline to 70 US cents this year if the Bank of Canada reduces interest rates more aggressively than the Federal Reserve. This scenario is becoming more plausible as the U.S. economy continues to show stronger performance compared to Canada. In response to recent developments, the loonie has already lost more than half a percent against the U.S. dollar following the Bank of Canada’s announcement last Wednesday, suggesting potential further declines.
Impact of U.S. Federal Reserve Policies
The strength of the U.S. dollar and the Federal Reserve’s cautious approach to rate cuts put additional pressure on the Canadian dollar. According to Derek Holt, vice-president and head of capital markets economics at the Bank of Nova Scotia, the Bank of Canada’s ability to cut rates without causing the Canadian dollar to plunge is increasingly constrained by the Federal Reserve’s policies. The Canadian dollar’s recent poor performance, despite rising oil prices, highlights this issue, with the currency down over four percent since mid-December.
Economic Indicators and Future Predictions
Economists Stefane Marion and Kyle Dahms from National Bank predict that the Canadian dollar will fall to 71 US cents in the third quarter and 70 US cents in the fourth quarter. They attribute this weakness to the potential divergence in monetary policy between the Bank of Canada and the Federal Reserve. Similarly, Benjamin Reitzes of BMO Capital Markets notes that while the Bank of Canada might want to reduce rates, doing so aggressively could weaken the loonie and counteract efforts to control inflation.
Potential Scenarios and Long-term Outlook
Royce Mendes from Desjardins Group suggests that the Bank of Canada can afford one or two rate cuts before the Federal Reserve starts easing, without causing significant issues. However, there is a limit to how much divergence can be tolerated. In the longer term, Jean-Francois Tardif of Timelo Investment Management warns that Canada’s inflation and affordability challenges, particularly in the housing market, could further depress the loonie, potentially seeing it drop to 50 US cents over time.