The loonie is faltering. Here’s why the U.S. Fed might provide a lift – National

Canadians may have noticed the value of their dollar dwindling ever since the Bank of Canada’s latest interest rate cut last week.

But it’s a decision from the U.S. Federal Reserve coming up this week that could have more of a say in whether the loonie holds pat for the rest of the summer.

Canada’s dollar is trading at a little over 72 cents compared with the U.S. greenback as of Tuesday. That’s roughly half a cent lower than it stood a week earlier, just ahead of the Bank of Canada’s meeting where it cut its benchmark interest rate by another quarter of a percentage point to 4.5 per cent.

Doug Porter, chief economist at BMO, said in a brief note to clients Tuesday morning that “the Canadian dollar is probing levels it hasn’t seen much in the past 20 years.”

He noted that the loonie’s value has dropped 1.5 per cent since the Bank of Canada’s rate cuts began in early June. The only recent cases where it has fallen lower were when oil prices took a steep hit in 2016 and the early days of the COVID-19 pandemic in 2020.

Porter noted that while the loonie has struggled against the U.S. dollar for a while now, recent weakness has seen the Canadian dollar also lag the euro, yen and pound.

The Bank of Canada’s easing policy rate, as well as a marked change in tone that suggests monetary policymakers are eyeing more cuts in the months ahead, is likely a big reason for the dollar’s weakness.

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“No doubt, the (Bank of Canada’s) very dovish stance is beginning to chip away at the currency,” Porter said, referring to the hints of further rate cuts to come.

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Could more interest rate cuts come from Bank of Canada?

One key factor that affects the exchange rate between the Canadian and U.S. currencies is the respective policy rates from the economic neighbours’ central banks.

With the Bank of Canada beginning its easing cycle well ahead of the U.S. Fed, investors are discouraged from parking their cash north of the border, driving interest away from the loonie.

The lower the Bank of Canada goes without the U.S. Fed following suit, the more damage could be done to the exchange rate.

This is an issue for more than just Canadian tourists trying to stretch their dollar as far as they can while they’re vacationing in the U.S. this summer.

There are implications for inflation, as well, as a weaker loonie makes U.S. imports more expensive. That’s particularly an issue heading into the fall and winter, when shelves in Canadian grocers are more often stocked with goods grown in the U.S. or farther abroad.

Bank of Canada governor Tiff Macklem has acknowledged that there is likely a “limit” to how much monetary policy in the U.S. and Canada can diverge, but has played down how closely the governing council is basing rate decisions north of the border on what’s happening to the south.

Macklem said at a press conference Wednesday that hopes for rate cuts starting soon in the U.S. should dampen the impact diverging interest rates could have on the Canadian dollar.

“With inflation showing more signs of easing in the United States, my sense is that divergence is not going to be particularly serious,” he said.

Indeed, inflation in the U.S. has shown renewed signs of easing as of late after a flare-up to start the year pushed back expectations for rate cuts from the Fed.

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U.S. Fed says it won’t cut rates until it has ‘greater confidence’ on inflation

While Chair Jerome Powell isn’t expected to deliver an initial interest rate cut at the upcoming decision on Wednesday, Porter said in his note that a “dovish” tone from the Fed “could provide support” for the flagging loonie.

But he added that the Bank of Canada’s “sanguine” outlook on the loonie’s prospects might keep the Canadian dollar “under a cloud” in the near term, as the central bank looks set to deliver more easing even as the U.S. Fed could be set to embark on its own rate-cut cycle.

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