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Loblaw has raised the prices of U.S.-sourced produce. But it’s lowering prices of other products to battle discounters.

Fernando Morales/The Globe and Mail

The weakening Canadian dollar threatens to play havoc with retailers' profits, raising their costs at a time when it's hard for them to increase prices to consumers.

The decline in the value of the loonie relative to the U.S. dollar will put pressure on margins, an internal report from the Retail Council of Canada warns – and the situation could worsen this year.

The report found that while a lower-valued loonie may discourage cross-border shopping and keep consumers spending at home, the declining dollar spells trouble over all for retailers.

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Intense competition means they may not be able to increase prices enough to cover their added costs, including labour and property expenses.

It could force some – particularly some clothing sellers – to "fall by the wayside" with short-term liquidations further depressing prices, the report said.

"It is hard to overstate how profound a challenge this represents to retailing," said the report, titled "Dollar dilemma dents outlook: another soft year, threatened by merchandise cost pressures" and marked "for members only."

"For years customers have enjoyed steady or falling prices. Now they see it as a permanent state of affairs and will certainly punish any retailer who breaks the faith. … This cost challenge could well pull some retailers under."

The report adds to growing evidence that a weaker loonie is putting new stress on merchants. It comes as retailers, which pay for much of their foreign inventory in U.S. dollars, face added competition from new players, pushing them to merge, make acquisitions or demand price breaks from suppliers.

"It's an ugly time to be in retail," said Luke Sklar, founder of consultancy Sklar Wilton & Associates, which advises packaged goods vendors and retailers. "It will be another sluggish year in Canada and this increases tension for all."

To gain economies of scale, Canada's two biggest grocers announced blockbuster takeover deals last year.

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Loblaw Cos. Ltd. has a $12.4-billion agreement to buy Shoppers Drug Mart Corp., while Sobeys Inc. acquired Safeway Canada for $5.8-billion.

Loblaw and Metro Inc. have moved to raise prices of U.S.-purchased fresh produce to cover higher currency costs. But they're lowering prices of other products as they battle the rise of discounters. And they're feeling the pinch of e-commerce which is starting to hit a critical mass in Canada and resulting in fewer shoppers heading to bricks-and-mortar stores, Mr. Sklar said.

The council's report, based on a mid-February survey of 51 large and mid-sized retailers that, combined, operate about 7,600 stores, is intended to be "directional" rather than statistically significant, council spokeswoman Sharon Armstrong said.

Steeper overall merchandise costs will "represent the most serious threat to retail success this year," the report said. Many retailers expect costs will rise more than 5 per cent, factoring in the effects of a lower loonie and higher costs in China and other supply countries. It expects other expenses, such as labour, property, transportation and overhead, to pick up 2 to 4 per cent.

Retailers are responding to changes by shrinking the size or even the total number of their stores because of e-commerce competition, rising real estate costs and time-pressed consumers who want to get in and out of stores quickly.

In 2013, holiday results were the the worst since 2008, hit by storms, store closings and power outages, the report said. A strong Black Friday – the adoption of the retail promotion that follows U.S. Thanksgiving – was followed by "empty stores and quiet websites" in the first two weeks of December," it said.

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"Margins took a double hit. The dramatic growth in sales during the Black Friday event meant a greater portion of holiday transactions took place at higher discounts."

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