July 17, 2015
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|USD vs CAD||
In not surprising that the Bank of Canada recently cut its benchmark interest rates by 25 basis points to 0.5 percent from 0.75 percent. This is the lowest level since 2009 when interest rates were at 0.25 percent. The reduction in interest rates also sent the Canadian dollar down to 77.40 cents (US), its lowest level since March 2009, and continued its drop today to another record low since 2009 to 76.97 cents US. Canada’s major banks also followed the central bank and lowered their prime lending rates but only by 15 basis points to 2.7 percent from 2.85 percent. This is the second time this year that the banks have taken a cautious approach to their lending rates after the central bank has slashed the interest rates. Overall, the banks have lowered their prime rates by a total of 30 basis points as compared to Bank of Canada’s reduction of 50 basis points. The lower interest rates have led to a surge in house prices and according to Bank of Canada’s estimates, housing market could be overvalued by as much as 30 percent. Apart from the housing market, consumers’ debt is rising at a record pace while the income is growing
at much slower pace. Due to low interest rates, consumers are taking on other forms of debts as well in the form of personal lines of credit, credit card loans among other types of debt. Fig 1. The surge in house prices combined with an alarming level of household debt for Canadians has prompted the big banks to lower their prime rates by 20 bps less than the central bank’s reduction of 50 points. In fact in 2007 Canadian versus US household debt to income was about the same. Since then Canadian Household debt to income has risen to 150% from 130% whereas US it has declined to 100% from the same level according to Deutsche Bank Fig. 2. The disparity creates an additional risk premium that adds pressure to the Canadian dollar decline.
The collapse in oil prices and subsequent reduction in the investments in the oil patch has created one of the highest trade gaps for Canada and the economy likely contracted by 0.6 percent and 0.5 percent in the first two quarters of 2015 – technically a recession. The recent victory by NDP in Alberta has further prevented the investments in oil sands by creating an uncertainty about the corporate tax structure for the province. In order to close or reduce that gap, the country needs to ramp up its non energy exports. It hasn’t happened so far yet and in a desperate measure to increase Canadian exports, Governor Stephen Poloz is trying to push the loonie lower in order to increase the competitiveness of Canadian exports. At a time when the Federal Reserve in the US is hinting towards a rate hike, this move by Bank of Canada shows that a growing US economy and a cheaper Canadian dollar could be the way to increase the Canadian exports and reduce the trade gap.
Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading Economics