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Posthaste: Should we be worried about our weak Canadian dollar whipping up inflation?

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canadian-dollar-inflation-0425

Good Morning!

The loonie has been taking it on the chin lately.

The Canadian dollar fell to a three-week low against the U.S. dollar last week after retail sales came in lower than expected, a signal that higher interest rates are starting to pinch.

“High mortgage rates are starting to bite Canadians’ wallets,” Adam Button, chief currency analyst at ForexLive, told Reuters. “Canada is particularly sensitive to higher interest rates and that will lead to divergence in U.S. and Canadian economic performance in the second quarter and beyond.”

The Canadian dollar hit its weakest intraday level since March 31 that day at 73.73 U.S. cents. Today the loonie slipped further to 73.65.

“A weaker Canadian dollar means higher import prices. That’s fine in normal times, but with inflation flying high already, the concern is that a weaker CAD could worsen the burden of high prices,” write RBC assistant chief economist Nathan Janzen and economist Claire Fan in a recent note.

“This could in turn push the BoC to follow the U.S. Fed by resuming rate hikes.”

But the economists argue that these concerns, though not unwarranted, “are often overblown,” and currency fluctuations matter less to prices than they once did.

For one thing Canada has become more of a services economy. About 80 per cent of the total value of goods and services consumed in Canada are now produced in Canada, according to the Organisation for Economic Co-operation and Development.

Over half of this is services, which includes things like rent, education and childcare that are provided within the country, said the economists. Even with imported goods much of the final price tag is tied to domestically produced services such as retail, wholesale and transportation, expenses that are not directly impacted by currency fluctuations.

At the same time, the U.S. dollar has become less important to imports into Canada than it once was. America is still Canada’s biggest trading partner, but that share is slipping. According to the OECD, the U.S. accounted for about 46 per cent of total Canadian consumption imports in 2018, down from 56 per cent in 1995. Most of this trade has gone to China which made up 12 per cent of total imports in 2018, compared to two per cent in 1995.

Since the Canadian dollar is stronger against the Chinese yuan, higher quantities of cheaper imports from countries other than the United States should offset some of the pressure caused by a strong U.S. dollar, said Janzen and Fan.

Even if the Canadian dollar fell against most other currencies, the impacts on inflation wouldn’t be as great as they once were, they said.

The Bank of Canada estimated in 2015 that a 10 per cent depreciation in the Canadian dollar would raise headline inflation by about 0.3 per cent, mostly on food and gas. But the economists say sensitivity has declined since then.

It is not the power of our dollar, but demand for services that will determine where inflation goes, they said.

And on this front they see positive signs. In the latest Bank of Canada survey, more consumers reported lower spending, especially on discretionary services, because of higher prices and borrowing costs.

“If that holds, we expect improvements in domestic price pressures, regardless of where the Canadian dollar might end up, said the economists.

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Federal government workers continued their strike for the seventh day today, affecting a wide range of public services from tax returns to passports. So how does this compare to past labour disputes between Ottawa and its employees so far?

Today’s chart from National Bank shows that there have been five major strikes by federal civil servants since 1945. The number of workers that can strike in this walkout (120,000 out of 155,000 union members) is lower than the 131,000 in 2004 but higher than the 75,000 in 1991.

This year, the public servants represent 0.6 per cent of Canada’s workforce, below the 0.8 per cent share in 2004. National Bank economists estimate that even if the strikers are out for 30 days the direct impact to gross domestic product would be about a 0.5 per cent hit — not enough to derail the economy.

  • Victor Fedeli, Ontario’s minister of economic development, job creation and trade, will make a speech at the Economic Club of Canada in Toronto

  • Today’s Data: The S&P CoreLogic Case-Shiller national home price index rose 0.2 per cent in February, following a 0.2 per cent fall in January

  • Also on deck today, U.S. New Home Sales and U.S. Conference Board Consumer Confidence Index

  • Earnings: General Motors, McDonald’s, Alphabet, Microsoft, Aecon Group, TFI International, West Fraser Timber

 

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Being an optimist sounds like a good thing, but being a realist armed with the facts is even better. Portfolio manager John De Goey says optimism keeps people invested, which tends to work out in the long run, but it’s important to understand where your biases lie and identify any resulting risks, especially those associated with overconfidence. Find out more

 

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Today’s Posthaste was written by Pamela Heaven, @pamheaven, with additional reporting from The Canadian Press, Thomson Reuters and Bloomberg.

Have a story idea, pitch, embargoed report, or a suggestion for this newsletter? Email us at posthaste@postmedia.com, or hit reply to send us a note.

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