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Rates and the Canadian Dollar

Two members of the C.D Howe Institute explore the dynamics of Canada’s elevated interest rate environment relative to the comparable countries in the article below. The point out that higher rates are driven by expected inflation rates in Canada. They point out that because of that dynamic, the loonie has been the strongest performer in the Group of 10 this year but that further appreciation in the Canadian dollar is not sustainable as it will lead to lower inflation, lower growth and ultimately lower relative rates. The key excerpt:
If Canada’s relatively high rate makes sense in the context of Canadian inflation and a steady economy, what besides an unexpected rise or fall in inflation might make it move in the months to come? People often expect relatively high nominal interest rates in Canada to exert upward pressure on the Canadian dollar. And, indeed, the loonie has been the best performer of all currencies in the Group of 10 area, with a 4.4 per cent appreciation with respect to the U.S. dollar this year. Further appreciation will cause both lower inflation, because the cost of imported goods falls, and a decrease in economic growth as aggregate demand for exports tumbles.

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