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Dollar has room to move higher The Canadian dollar may be overvalued based on various measures, but economists believe it could move higher yet.
Different models value the loonie, which has been hovering around parity with the U.S. dollar, at different levels, but trading at more than it's worth. Still, given a variety of factors, it's expected to stay at lofty heights.
BMO Nesbitt Burns, for one, says its model, which factors in commodity prices, interest rates and inflation differentials, pegs the fair value of the currency at about 93 cents U.S., while the Organization for Economic Co-ordination and Development puts the loonie's purchasing power parity value at just 82 cents.
Still other models, according to economist Charles St-Arnaud of Nomura Securities International in New York, show it overvalued by 10 per cent, 15 cent and even 30 per cent or more, though he believes it's not "significantly" overvalued at all, based on various factors.
While valuations are all over the place, based on different models and against various currencies, BMO expects the loonie to trade at or above parity this year and next.
"Most models show the Canadian dollar is overvalued, but that doesn't mean the currency can't deviate a little further from its fundamentals," said BMO economist Benjamin Reitzes. "The ducks are all in a row for the loonie to fly still higher."
Here are four reasons why, according to Mr. Reitzes:
1. Exposure to commodity prices. "Rising commodity prices increase our terms of trade, making Canadians relatively wealthier and boosting the loonie."
2. Fiscal and financial strength. "While household balance sheets are now a little stretched, a sound financial system makes Canada a more attractive investment destination."
3. Interest rate spreads. "We expect the Bank of Canada to resume tightening in May, with the policy rate rising 100 basis points to 2 per cent by year-end. That should widen Canada-U.S. interest rate spreads at the short end through most of 2011, which will benefit the C$."
4. Weakness of the U.S. dollar. "Fiscal and financial sector issues plague the U.S., and solid global growth feeds risk appetites, none of which bode well for the greenback. Its role as a reserve currency is also being questioned."
The loonie took off at the beginning of the year, though has lately lagged other currencies. But it would be a mistake to see that lag as the most likely trend this year, said David Watt, senior currency strategist at RBC Dominion Securities, citing, among other things, the Bank of Canada.
"While the BoC remains cautious and inflation pressures in Canada are currently benign, the BoC is going to raise rates this year," Mr. Watt said, adding that, like Mr. Reitzes, he expects the central bank's benchmark overnight rate to reach 2 per cent by the end of the year, beginning with increases in the second quarter.
"The retreat in BoC rate expectatations is inappropriate," he said. "As they are reversed, [the Canadian dolar] will regain traction."
Euro zone leaders consider bond buy backs
Euro zone leaders desperate to put a lid on the region's financial crisis suggested Friday that the European Financial Stability Facility could be used to buy back national bonds. French Finance Minister Christine Lagarde said European leaders have been talking about using the facility -- which was created six months ago to assist heavily indebted euro zone members -- could be used to purchase euro zone bonds, AFP reported from the World Economic Forum in Davos.
"We are discussing it at the moment, I don't think there is yet general consensus because it's again work in progress," Ms. Lagarde told AFP. "But it's clearly one avenue for the EFSF to actually get involved in markets."
Japan can't break deflation's back Japan has been unable to break out of its deflationary cycle.
Core consumer prices, which exclude some volatile food items but includes oil, fell 0.4 per cent in December from a year earlier. That's a slower pace than earlier, and better than economists had projected, but it still marks 22 consecutive months of declines.
Separately, Japan's statistics bureau said today, the country's unemployment rate dipped to 4.9 per cent from 5.1 per cent. That's the first decline in the jobless rate since September.
The numbers came a day after Standard & Poor's downgraded Japan's sovereign debt, spelling more trouble for the embattled economy.
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