Canada: Uh-Oh. The Loony Is Looking Limp

The Canadian dollar's rapid deterioration is crimping the Bank of Canada's stimulus plan.

The dollar, nicknamed the loony, sunk to a record low of 62.3 cents U.S. on Nov. 9, a large drop of 5% since June (chart). The loony enjoyed a rally on Nov. 13, but it will be short-lived. Traders are pushing down the loony because of falling prices for commodities, lower interest rates, and weak stock prices.

The currency's fall comes as Canada wrestles with signs of a recession. Unemployment in October edged up to 7.3%, a two-year high. The October purchasing managers' index rebounded from September's 45.4%, but last month's reading of 48.5% suggests that the industrial sector is in a recession. And business sentiment continued to fall. After the September 11 attacks on the U.S., security measures at border crossings are delaying the movement of goods and adding to company costs.

Nonetheless, the BOC sounded cautiously optimistic in its November Monetary Policy Report. The report estimated that real gross domestic product probably fell by as much as a 1% annual rate in the third quarter and that growth in this quarter will be flat. But in 2002, the MPR said, real GDP will likely grow 1.5%. Slower growth will bring down inflation, probably to "well below" 2% next year.

The BOC has already cut interest rates eight times this year, including a surprisingly large three-quarter-point reduction on Oct. 23. Analysts expect another cut at the Nov. 27 meeting. But the BOC will be flying solo in its policy efforts, since the budget plan expected in December is likely to propose limited fiscal stimulus.

Lower short-term rates, however, mean more erosion in the dollar. And while that may help make manufactured exports more attractive, it will do little for major Canadian exports, like oil and commodities that are mostly priced in U.S. dollars. Plus, the pronounced weakening in the loony will hurt investor interest in Canadian securities. That will raise long-term rates, hurt Toronto's equity markets, and delay the recovery.

By James C. Cooper & Kathleen Madigan

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