High loonie will keep rates low until 2014, TD says

Massive injections of money by central banks to aid ailing economies is having the effect of keeping the Canadian currency higher than it otherwise would be against other major currencies, TD Bank economists said Thursday.

In their analysis, Craig Alexander and Francis Fong conclude that, among other factors, will keep the Bank of Canada from raising interest rates until the last quarter of next year, and then only then by about half a percentage point in a series of moves.

The report came as the Canadian dollar drifted higher Thursday after the latest trade figures showed Canada's merchandise trade deficit narrowed in January.

The loonie closed up 0.19 of a cent at 97.14 cents US over its official Bank of Canada close yesterday after Statistics Canada said the trade deficit with the world narrowed to $237 million in January from $332 million in December.

On Wednesday, it fell 0.33 of a cent after the Bank of Canada kept its key rate unchanged at one per cent and indicated that persistent economic weakness and low inflation means a hike is a long ways off.

Stimulus injections, especially by central banks in the U.S., Europe and Japan, have been aimed at keeping interest rates low, to encourage spending and investment.

But those moves also lower the relative values of their currencies.

Since the beginning of the year, the U.K. pound has fallen by more than six per cent against the U.S. dollar, and in five months the Japanese yen is down more than 20 per cent against the greenback.

“There is little question that foreign exchange rates are being affected by central bank actions around the world,” the economists say in their analysis, adding that ”it is evident that more stimulus is on the way.”

The loonie fell more than three cents over February as the Canadian economy showed signs of weakening more than anticipated, and with inflation falling.

Alexander and Fong maintain that the loonie’s fair value is about 91 cents US, when adjusted for the relative purchasing power of each currency.

For an export-focused economy such as Canada's, having an artifically high currency inhibits growth, and raising interest rates would only add to that trend, prompting Alexander and Fong All to push back their expectations for when the Bank of Canada will start raising rates.