Too much currency strength?

A longer-term monthly chart of USD/CAD shows a substantial appreciation in the Canadian currency from January 2002, when the pair was trading at $1.61, to the USD/CAD bottom in November 2004.

By the end of 2004, economists said the hefty appreciation in the Canadian currency actually began to dampen the export sector and was a factor in slowing the growth.

“BOC members weren’t too happy with the strength in the Canadian dollar,” says Tim Mazanec, senior forex strategist at Investors Bank and Trust. “A dollar-seventeen was too strong.”

Fourth quarter 2004 GDP data came in at 3.0 percent. But the weakening of the export sector, with 3 percent annualized declines in both the third and fourth quarters in 2004, translated into slower economic growth in early 2005. However, domestic demand seems to have stepped in to fill at least some of the void.

“There has been a reversal in the drivers of growth in Canada,” explains Charmaine Buskas, economist at Economy.com. “In 2003 and 2004, exports were driving the economy.

But by the end of 2004, exports started to soften as we saw a very strong currency. We also had a slowdown in global and U.S. demand for Canadian exports.”

Nonetheless, a surge in domestic demand, with improving employment numbers and signs of stronger retail sales data, has been carrying the Canadian economy.

“Domestic demand is a very large portion of the Canadian economy,” says Buskas. “But I don’t think the Canadian consumer has enough wherewithal to pick up the entire drop-off from the export side.”