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No stopping the loonie, as it hits one-year high in likely return to parity

October 8, 2009

THE CANADIAN PRESS, October 8, 2009 6:46 PM

By Julian Beltrame, 

The Canadian dollar again appears to be heading towards parity with its American counterpart.. THE CANADIAN PRESS/Paul Chiasson
OTTAWA - The Canadian dollar rose to a new one-year high on Thursday even as the Bank of Canada warned once again that a strong loonie will undermine economic growth.

But with the world recovery from the so-called Great Recession picking up steam and supporting commodities that Canada has in abundance, the loonie appears to be headed for parity, and sooner than expected, economists say.

Douglas Porter of BMO Capital Markets said his bank's official forecast is for the loonie to reach parity with the U.S. dollar on a sustained basis by middle of next year, but he conceded it could be sooner.

"Once markets focus on a target, they sometimes act like a dog with a bone," Porter said.

The loonie has been gathering momentum for more than a week and had another strong day Thursday, gaining 0.91 cents to close at 95.04 U.S., the best showing since Sept. 29, 2008. It hit an intraday high of 95.18.

CIBC currency analyst Shane Enright said the mood of markets is similar to the updraft in the first half of 2007 that saw the loonie soar to US$1.10.

The Bank of Canada has been trying to talk the loonie down since at least June, and was at it again Thursday with senior deputy governor Paul Jenkins warning about the loonie's affect on the economy in a speech in Vancouver.

"All else being equal, a persistently strong Canadian dollar would also reduce real growth," he said.

In one sense, the a strong dollar does some of the heavy lifting for the bank in controlling inflation by tempering the price of imported goods. But it is regarded as a net drag on the economy by making Canadian exports uncompetitive in foreign markets.

In the past, bank officials have warned that they retain plenty of flexibility to weigh down the loonie, but Jenkins was less direct about policy responses Thursday.

Economists say there is only so much the central bank can practically do restrain the currency since it has already slashed the policy interest rate at the practical zero level, at 0.25 per cent, and pledged to keep there until at least next July.

Economist Paul Gauthier of TD Bank said his belief is that while the central bank is concerned about the loonie being overpriced, its bigger lament is with sharp and sudden swings in the currency that make it difficult for businesses to plan ahead.

Some have speculated the loonie's strength is based partly on the market's believe the Canadian central bank will soon follow Australia's lead this week and start raising rates sooner than it has maintained.

But Jenkins appeared to throw cold water on the notion in his speech, suggesting that economic growth in Canada is likely more fragile than the bank's most recent assessment.

"It would appear...that some of this stronger growth reflects the effects of temporary factors, such as the impact of the U.S. 'cash-for-clunkers' program on Canadian automotive production," he cautioned.

Economists cited several factors for the loonie's appreciation, including general U.S. currency and economic weakness, and building demand for commodities, particularly oil. The price of crude has gained about three per cent this month and is once again above US$71 a barrel.

And the loonie may get another boost Friday when Statistics Canada issues its jobs report. The consensus is that the economy created 5,000 in September, after a 27,000 pickup in August.

That is a modest number, but marks a major difference from the situation in the U.S. - against who the currency the loonie is measured. The U.S. is still being hammered by massive three-digit monthly job losses - it hasn't had a positive reading in almost two years.

"It's just another report that is likely to highlight the stark difference between the U.S. and Canadian economies," Gauthier said.

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