Currency Profiles: Guide to Developed Countries Currencies

Canada

Economic Performance

Canada is the 7th largest country in the world with GDP valued at $700bln in 2001. The country has been growing consistently since 1991. Canada is currently the world's 5th largest producer of gold and the 14th largest producer of oil. However, two-thirds of the country's GDP comes from the service sector, which employs 3 out 4 Canadians. Manufacturing and resources are very important for the Canadian economy, as it represents over 25% of the country's exports.

Monetary & Fiscal Policy

The Bank of Canada (BoC) determines monetary policy for Canada. The Bank does not have periodic policy setting meetings. Instead, the council meets on a daily basis and changes in policy can be made at any point in time.

The Bank of Canada's focus is on maintaining the 'integrity and value of the currency.' This primarily involves ensuring price stability. Price stability is maintained by adhering to an inflation target agreed upon with the Department of Finance. This inflation target is currently set at 1% - 3%. The BoC controls inflation through short-term interest rates. Monetary conditions tighten when short-term rates increase or the trade weighted Canadian dollar appreciates.

In order to change monetary policies, the Bank would manipulate the Bank Rate, which would affect the exchange rate. If the currency appreciates to undesirable levels, the BoC can decrease interest rates to offset the rise. If it depreciates, the BoC can raise rates. However, interest rate changes are not used for the purposes of manipulating the exchange rate. Instead, it is used to control inflation.

The following are the most commonly used tools by the BoC to implement monetary policy:

Bank Rate: This is the main rate used to control inflation. This is the rate of interest that the Bank of Canada charges to commercial banks. Changes to this rate will affect other interest rates, including mortgage rates and prime rates charged by commercial banks. Therefore changes to this rate will filter into the overall economy.

Open Market Operations: The Large Value Transfer System (LVTS) is the framework for the BoC's implementation of monetary policy. It is through this framework that Canada's commercial banks borrow and lend overnight money to each other in order to fund their daily transactions. The LVTS is an electronic platform through which these financial institutions conduct large transactions. The interest rate charged on these overnight loans is called the overnight rate or bank rate. The BoC can manipulate the overnight rate by offering to lend at rates lower or higher than the current market rate if the overnight lending rate is trading above or below the target banks.

On a regular basis, the bank releases a number of publications that are important to watch. This includes a biannual Monetary Policy Report that contains an assessment of the current economic environment and implications for inflation and a quarterly Bank of Canada Review that includes economic commentary, featured articles, speeches by members of the Governing Council and important announcements.

Important Characteristics of the Canadian dollar

  Commodity linked currency

Canada's economy is highly dependent on commodities. The positive correlation between the Canadian dollar and commodity prices is close to 60%. Typically, as commodity prices increase, the CAD$ increases and when commodity prices decrease, the CAD$ declines.

  Strong correlation with the US

The US imports 85% of Canada's exports. The Canadian economy is highly sensitive to changes in the US economy.

  Mergers and acquisitions between firms in the US and Canada are very common

Due to the proximity of the US and Canada, cross border mergers and acquisitions are very common, as companies worldwide strive for globalization. These mergers and acquisitions lead to money flowing between the two countries, which ultimately impact the currencies.

  Interest rate differentials between the cash rates of Canada and the short-term interest rate yields of other industrialized countries are closely followed

Interest rate yield differentials provide traders with indications of potential currency movements, as investors are always looking for assets with the highest yields.

  Carry trades

When Canada has a higher interest rate than the US, the sell USD, buy CAD carry trade becomes more popular due to the proximity of the two countries.

Important Economic Indicators for Canada

  Unemployment

  Consumer Price Index (CPI)

  Gross Domestic Product (GDP)

  Balance of Trade

  Producer Price Index (PPI)

  Consumer Consumption

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