Bank of Canada hints at stronger Canadian dollar

flovestock

PATRICIA CROFT
Globe and Mail Blog
Posted on Wednesday, May 18, 2011 10:44AM EDT

Earlier this week, Bank of Canada governor Mark Carney gave a remarkable speech entitled "Canada in a Multi-Polar World".

In a relatively short address, Mr. Carney covered a myriad of topics, centered on the theme of Canada’s place in a changing world. The global economy is in the midst of a powerful transformation, with the pace of change accelerated by the recent financial crisis.

The world today is no longer U.S.-centric but rather multi-polar, led by the economic titans of emerging Asia -- China and India. This transformation has just begun and will take time to unfold, measured in decades rather than years. It will provide both challenges and opportunities for Canada.

Opportunity lies in the pressing need for Canadian companies to tap in to the extraordinary theme of the rise of the Asian middle-class consumer. According to the Bank, this new middle class is growing by 70 million people per year, and by the end of this decade, will account for 40 per cent of the world’s population.

Today, only 10 per cent of Canada’s exports are destined for emerging markets. Our economic engine is still far too closely aligned with the United States, a country seemingly destined for a considerable period of subpar growth, hamstrung by fiscal challenges and continued balance sheet adjustment by consumers and the banking system. The opportunity is clear.

One of the key challenges for Canada lies in the outlook for the value of the Canadian dollar. I believe the new paradigm outlined by Mark Carney implies that the Canadian dollar will not only remain above par, but will strengthen further. Mr. Carney outlines four factors that will support Canadian dollar strength.

Firstly, we are in the midst of a commodity price super cycle -- there will be fluctuations in prices but the cycle could proceed for some time reflecting fundamental Asian demand. Capital flows are also critical. Foreign central banks have already begun the process of diversifying their massive reserves away from the U.S. dollar and in to free floating currencies like the Canadian dollar.

Investors are reallocating portfolio flows to partake in the theme of rising emerging markets and strong commodity prices -- this could benefit proxy currencies such as the Australian and Canadian dollars. Finally, with some countries restricting capital flows and free-floating currencies, the process of U.S. dollar depreciation plays out in the appreciation of floating currencies of developed economies such as Canada. I believe this suggests our dollar will continue to appreciate and that the Bank of Canada will be very cautious in the process of raising Canadian interest rates later this year, acutely aware that a rapid rise in relative interest rates would only add fuel to the fire of the Canadian dollar’s inevitable appreciation.