Bank of Canada governor Stephen Poloz delivered his message loud and clear Wednesday morning: he's more concerned about disinflationary trends – or even outright deflation – than he is about our battered currency.
Investors are responding in kind. The dollar is down nearly a cent since markets opened Wednesday, marking a four-year low. The loonie has now dropped 11 per cent since this time last year, and shows few signs of bottoming. The latest data out of the Commodity Futures Trading Commission shows over 70,000 futures contracts shorting the Canadian dollar.
The domestic growth outlook has soured over the past year, but a large part of the loonie's decline is a result of monumental shifts south of the border. After the U.S. Federal Reserve began tapering its quantitative easing program, the greenback shot higher against other major currencies. Canadian bond yields will remain under intense pressure. Meanwhile, U.S. government bond yields continue to rise on expectations that the Fed will keep cutting back on its bond purchases. The growing divergence in yields leaves more room for the Canadian dollar to fall vis-a-vis the U.S. dollar, as relatively higher U.S. rates prove attractive to investors. Mr. Poloz's dovish rhetoric this morning gave speculators the green light for further depreciation.
Expectations are shifting, indicating that the new normal for the Canadian dollar may be $0.90 (U.S.) or lower in the next few years. Economists across the board are trimming forecasts for the loonie; Goldman Sachs predicts the currency to drop towards $0.88 this year, while TD expects the loonie to push towards $0.87 in 2015.
Right now, a lower Canadian dollar is welcomed as an inadvertent easing tool, allowing the Bank of Canada to avoid cutting interest rates. If a weaker loonie proves to be more than a short-term readjustment to U.S. policy, and more of a reflection of medium-term fundamentals, this should theoretically filter through into rising inflation. The less powerful our currency is relative to currencies such as the U.S. dollar, in which many of our imported goods are priced, the more it costs to buy those goods, driving prices higher for consumers.
But inflation is currently nowhere to be found. In fact, headline inflation rates in developed countries have declined considerably from a year ago. The latest domestic reports show that the Canadian CPI grew by 0.9 per cent year over year, well below the Bank of Canada's ideal target of 2 per cent.
Until that changes, Mr. Poloz – along with European Central Bank governor Mario Draghi and Bank of England governor Mark Carney, all of whom are facing the spectre of disinflation – will tread lightly on interest rates.