Loonie under pressure, but for how long?

In Canada, the policy rate will be lowered tomorrow for the third time in half a year. The Canadian dollar is also under considerable pressure. But that could change later this year, if other central banks follow the interest rate example.

The Canadian dollar has been in a bit of a pickle lately. Compared to the euro, the currency has lost almost 13% of its value in two years. Initially, this slide could not be seen separately from a falling oil price. In the summer of 2022, a barrel of Brent oil was still trading for more than $100. Now, that same barrel is being paid for around $75. After Saudi Arabia and Russia, Canada is the world's largest oil exporter. When the oil price falls, this is often felt quite a bit in the value of the Canadian dollar. However, there has been more going on with the loonie, as this currency is also known, lately.

Economy could use a boost
The Canadian central bank is about to cut its policy rate by 25 basis points and give the economy some breathing space. Lower interest rates make it attractive for companies and consumers to borrow money for investments or spending. The economy could certainly use such a boost. Unemployment has risen from less than 5% in the summer of 2022 to 6,4% in July. That is quite a difference with the United States. In the southern neighbor, unemployment is just above 4%. A major difference is that the Bank of Canada (BoC) has a bit more room to stimulate the economy. Inflation of 2,5% is within the target range of 1% to 3%.

Interest rate differential is making itself felt
The BoC has already made grateful use of that space. If the interest rate is cut by 0,25 percentage points during the policy meeting, that will be the third cut in half a year. That is quite a contrast with the European Central Bank (ECB), which has made only one interest rate move this year. In the United States, financial markets have even been waiting for months for the first interest rate cut since 2020. That difference is clearly felt on currency markets. Despite the fact that the fall in the oil price is clearly weakening, the loonie remains under pressure. The lower interest rate makes it increasingly less attractive for parties to hold assets in this currency.

Focus shifts
Whether the pressure on the Canadian dollar will continue in the coming months will largely depend on how the BoC explains its interest rate decision. If it anticipates another series of rate cuts in the coming quarters, the loonie will take another step back. But if the central bank takes a more cautious approach, the focus will shift to the Federal Reserve and the ECB. In Europe in particular, the central bank seems to prefer to stimulate the sluggish economy rather than wait for more evidence of falling inflation. It could therefore be that interest rates on our continent will follow those of Canada.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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