Canada Dollar Drops After Central Bank Cites Currency’s Strength

The Canadian dollar reached the weakest in more than four years after the Bank of Canada lowered its inflation forecast and said the currency remains strong enough to be a competitive challenge for the nation’s exports.

The currency extended a four-month slide versus its U.S. peer as the central bank kept its benchmark interest rate at 1 percent, as forecast by every economist in a Bloomberg survey. It’s been unchanged since September 2010. Bank Governor Stephen Poloz said the direction of his next move will depend on the economy’s evolution. He refrained from inserting language into the bank’s statement on a need for lower interest rates.

“Everything they’ve said here so obviously welcomes the currency going down it would be a small step from that to start allowing the currency to drive domestic policy,” said Adam Cole, head of Group of 10 currency strategy at Royal Bank of Canada, by phone from London. “Even though they didn’t move to an easing bias, it takes us a step closer to that, maybe.”

The loonie, as Canada’s currency is nicknamed for the image of the aquatic bird on the C$1 coin, depreciated 1.1 percent to C$1.1087 per U.S. dollar at 5 p.m. in Toronto. It touched C$1.1092, the weakest since Sept. 2, 2009. One Canadian dollar buys 90.20 U.S. cents.

The currency fell versus 15 of its 16 major counterparts tracked by Bloomberg. It has dropped 4.2 percent against the U.S. dollar in January.

‘Competitiveness Challenges’

“Despite depreciating in recent months, the Canadian dollar remains strong and will continue to pose competitiveness challenges for Canada’s non-commodity exports,” the bank said in its quarterly Monetary Policy Report.

Canada’s benchmark 10-year government bonds rose, with yields falling two basis points, or 0.02 percentage point, to 2.49 percent. The price of the 1.5 percent security maturing in June 2023 added 13 cents to C$91.79.

The interest-rate advantage of the U.S. Treasury 10-year note over its Canadian counterpart increased to 37 basis points, the most since June 2009, increasing the relative allure of U.S. securities as policy expectations in the two countries diverge.

The Federal Reserve is reducing its monetary stimulus. The U.S. central bank has cut monthly bond buying to $75 billion, from $85 billion, and economists in a Bloomberg survey Jan. 10 forecast it will keep tapering the purchases in $10 billion increments at each of its policy meetings this year.

Excess Capacity

The Canadian economy still has “significant” excess capacity and inflation is being held down by global weakness in food prices and a recent increase in retail competition, the Bank of Canada said. Consumer prices will advance at an average year-over-year pace of 0.9 percent in the first quarter, below the bank’s 1 percent-to-3 percent target band, before quickening to 1.5 percent in the fourth quarter.

Poloz predicted that the currency’s recent weakening should help exports.

The Canadian dollar has fallen against all of its major peers since the end of December as Poloz has said he’s concerned inflation is too low. It has been below the Bank of Canada’s target band for two months, and lower than 2 percent for 19 months.

Data this week will show consumer prices for December increased 1.3 percent on an annualized basis, according to economists in a Bloomberg survey.

Canada’s manufacturing base has shrunk, meaning a weaker currency will provide less of an economic spark that it would have in the past.

‘Smart Strategy’

The rate decision has “changed everything, because essentially they’ve told us they’re targeting a long-term exchange rate,” said Sebastien Galy, senior currency strategist at Societe Generale, by phone from New York. “It’s probably a smart strategy to reset the Canadian dollar to a level that’s compatible with the manufacturing sector.”

Poloz surprised investors in October by dropping language from the bank’s policy statement about the need for future interest-rate increases, citing slack in the economy. The language had been in place for more than a year.

The Canadian currency lost 1.4 percent over the past week in a basket of 10 developed-nation peers tracked by the Bloomberg Correlation-Weighted Index. It was the worst performance. The U.S. dollar gained 0.2 percent.

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