Canada Seen Rebounding as Currency of Choice in Harper Mandate

Investors worldwide have a reason to make Canada the economy of choice after Prime Minister Stephen Harper’s decisive election earlier this week ratified policies that helped the government outperform most of its peers among the Group of Seven industrialized countries.

After the Conservative Party won the first majority in the Ottawa-based House of Commons in seven years, Harper vowed to fulfill his pledge to eliminate the budget deficit by 2014 and cut corporate taxes and spending.

The Canadian dollar may be an early winner after sliding for a month against almost all major currencies on concern that Harper’s push for control would fail. The currency may be buoyed by forecasts that Canada’s growth will match the U.S. as the fastest in the G-7 after recouping the jobs lost during the recession. Societe Generale SA and ING Financial Markets, the two most bullish forecasters, see the currency gaining 3.4 percent versus the U.S. dollar by year-end, according to data compiled by Bloomberg.

“The election of a government with a pro-business agenda is good for risk assets such as the currency, stocks and bond spreads,” said Ed Devlin, a London-based portfolio manager at Pacific Investment Management Co., manager of the world’s largest bond fund. The currency will be well-supported by its economy, Devlin said, citing “fundamental strengths to Canada relative to the rest of the G-7.”

Keeping Up

Societe Generale and ING anticipate the currency strengthening to 92 cents to the U.S. dollar by year-end, from 95.24 cents yesterday, Bloomberg data show. Strategists are struggling to keep up with the so-called loonie’s gains, boosting their median year-end estimate to 97 cents from $1.01 in January.

The victory by Harper, 52, came three weeks after the International Monetary Fund predicted the world’s 10th largest economy will expand 2.8 percent this year, while inflation will end the year near the Bank of Canada’s 2 percent target. An average unemployment rate of 7.6 percent will be bettered only by Japan and Germany in 2011. At 84 percent, Canada’s gross government debt as a proportion of its economy is smaller than the 100 percent level projected for the U.S., according to the Washington-based lender.

Canada weathered the financial crisis better than the rest of the G-7 even as pressures from abroad tipped it into recession and sent its jobless rate to a four-year high. Still, Royal Bank of Canada and the country’s other 20 banks received no public money during the credit turmoil, and the country’s financial regulations have inspired reforms elsewhere.

Policy Certainty

Certainty in policy making may also set Canada apart, said Geoffrey Yu, a currency strategist at UBS AG in London. The U.K. and Germany are run by coalition governments, French President Nicolas Sarkozy and Japan’s Prime Minister Naoto Kan have become unpopular with their electorates, while in the U.S., Democratic President Barack Obama must negotiate with a Republican-run House of Representatives.

“Canada is now one of the few G-7 economies which will enjoy a stable, majority government which is not at risk of being deadlocked or even brought down, either by coalition friction or constitutional separation,” said Yu. “This will allow the Canadian dollar to enjoy a strong political premium and outperform.”

Canada’s status as the G-7’s only major exporter of commodities gives it another advantage, Bank of Canada Deputy Governor John Murray said Feb. 10. Goods such as oil and wheat make up about 11 percent of Canada’s gross domestic product and one-third of its exports. Wheat futures have jumped 58 percent in the past year on the Chicago Board of Trade, and oil futures traded on the New York Mercantile Exchange have climbed 29 percent.

Energy ‘Superpower’

Finance Minister Jim Flaherty called Canada an energy “superpower” in a Dec. 9 speech in New York, noting the country is the world’s second-largest producer of nickel and third-largest producer of aluminum and natural gas.

Canada’s dollar could be as big a winner as Harper this week, said Greg Anderson, a senior currency strategist at Citigroup Inc. in New York. After proving the best performing currency in the G-7 over the past two years, the loonie fell almost 3 percent against the euro and yen in the month before the election and more than that versus the Australian dollar and Swiss franc. It gained 1 percent against the U.S. dollar.

The election result reduces the risk that the coalition partners would impose a constant threat of early polls or deal-making, and it empowers fiscally conservative policy makers to open up to foreign investment, Anderson said.

Pre-Election Speculation

“A Conservative victory should be a long-term positive,” he said. He predicts the currency may strengthen to C$1.02 per Australian dollar this week as the election “risk premium” diminishes. The Canadian dollar fell to its lowest against its Australian counterpart since February 2004 last week on speculation Harper wouldn’t secure a majority.

“Canada is a poster-child for the rest of the G-7,” said Jim O’Neill, chairman of Goldman Sachs Asset Management in London, who remembers lamenting the state of the economy when he entered banking three decades ago. “They have commodities, links to growth-driving economies such as China and very solid policies and governance. It’s hard to pinpoint what its immediate challenge is.”

Canada’s economy unexpectedly shrank 0.2 percent in February following four months of expansion, as production dropped at factories and wholesalers, Statistics Canada said April 29. The Bank of Canada said last month growth will slow after a burst at the start of the year, with auto production hampered by Japan’s earthquake and exports curbed by a strong dollar.

Growth Forecasts

The economy will grow at a 2 percent annualized pace in the April-June period following a 4.2 percent expansion in the first quarter, the Ottawa-based central bank said in its Monetary Policy report. Output will grow at a 2.7 percent rate in the second half of 2011, the April 13 report said.

Bond and equity investors may also cheer the Conservative victory, said Stephen Gauthier, a money manager at Fin-XO Securities in Montreal, which oversees about C$600 million. Foreign investors last year rewarded the government’s relative fiscal prudence with record purchases of Canadian bonds. They have returned 4.8 percent over the past year, according to Bank of America Merrill Lynch index data, compared with a 3.2 percent average for the G-7.

Corporate Taxes

Harper sought re-election on a plan to maintain reductions in corporate tax rates for companies such as Royal Bank of Canada and Barrick Gold Corp. that would cost the government more than C$6 billion in revenue next year. He argues lower taxes are needed to sustain the recovery and generate jobs.

He also promised to resist restrictions on foreign investment even after becoming his nation’s first leader in more than two decades to reject foreign takeovers. A Harper majority also means the country’s oil companies will have an advocate in Ottawa, after other parties pledged to eliminate tax breaks and subsidies for the industry.

“I don’t see anything negative as far as the markets are concerned,” Gauthier said. “They won’t have to deal with a party that was biased toward more spending and higher taxes.”

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