Exchange rate hampering Bank of Canada's ability to slow growth in
TORONTO, Dec. 17 /CNW/ - CIBC (CM: TSX; NYSE) - The growing appeal of
Canada to foreign investors, including central banks, may be
overheating the value of the loonie, further hurting an already
battered Canadian manufacturing sector and making it difficult for the
Bank of Canada to raise interest rates to slow growing household debt,
finds a new report from CIBC World Markets Inc.
While Bank of Canada Governor Mark Carney recently warned of a "death
grip" on the U.S. dollar, given that over 40 per cent of America's
trade is now with countries with managed exchange rates against the
greenback and more than a dozen countries seeing double-digit growth in
their reserves, the report notes the Canadian dollar may also be in a
"death grip" of its own.
"Reasonable decisions by central banks to diversify their reserve
holdings, including added weight in the Canadian dollars, may have been
a key factor in driving our currency to parity vs. the U.S. unit,
offsetting a large trade deficit," says Avery Shenfeld, chief economist
at CIBC. "Precise data on such flows aren't available, and much of the
foreign ownership of Canadian bonds is likely in private sector hands.
But a significant share of the growth of late, and it's been massive,
appears to be linked to central bank reserves and other sovereign
The CIBC report found that foreign investors added more than $72 billion
to their Canadian dollar bond holdings in the past 12 months, nearly
enough to finance last year's entire federal and provincial deficit.
The majority of that has been in Government of Canada issues, the
favoured vehicle for central bank reserves.
Canadian dollar central bank holdings are lumped into an "other"
category in IMF data that would also include the Australian dollar and
a few others, with most emerging economies not reporting on the
composition of their holdings. Mr. Shenfeld believes these
non-reporters are following a similar allocation. Using a reasonable
estimate of Canada's share of that "other" group, he estimates central
banks might be accounting for a third-to-a-half of the net new foreign
buying, which is also in line with anecdotal evidence from market
"Those central banks are not, of course, trying to control their
currency's cross against the Canadian dollar, since the bilateral trade
flows that would be affected would be modest," adds Mr. Shenfeld. "Nor
are they directly aiming at driving the loonie up against the U.S.
unit. But that is still the outcome."
The elevated value of the loonie has hamstrung the Bank of Canada in its
efforts to stem the rapid growth in consumer debt through interest
rates hikes. A CIBC Economics analysis in the report shows that
Canada's current debt load is not problematic, but if maintained, the
present pace of borrowing could put a squeeze on household finances
five years out.
The Bank can't move to raise interest rates to deter additional
borrowing for fear of sending the loonie even higher and putting
further drag on exports. Already, the Canadian dollar's appreciation
has contributed to Canada losing more than a quarter of its 2001 share
of the U.S. import market.
While many are now looking to the federal government to put the brakes
on household borrowing, the report suggests Bank of Canada Governor
Mark Carney has another option.
"There is one weapon yet to be touched: fighting fire with fire," says
Mr. Shenfeld. "Canada could match foreign central bank intervention in
favour of our currency with an offsetting intervention, selling an
equivalent volume of loonies. That would simply move back to market
determined exchange rates, and would loosen the death grip on the
Mr. Shenfeld notes that while global policy makers have devoted a great
deal of time and effort to developing financial sector reforms based on
the lessons from the past economic crisis, Canadian policy makers may
want to pay a little more attention to the impacts of an imbalance in
trade tied to misaligned currencies, another key factor in the recent
troubles that tripped up the global economy.
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/sdec10.pdf.
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SOURCE CIBC World Markets
For further information:
Avery Shenfeld, Chief Economist, CIBC World Markets Inc. at (416) 594-7356, firstname.lastname@example.org; or Kevin Dove, Communications and Public Affairs at 416-980-8835, email@example.com