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Canadian Dollar Overvaluation Worsens

ByThe National Bank of Canada
Published 08/13/2012, 02:11 AM
Updated 05/14/2017, 06:45 AM
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With Q2’s ugly trade results, we’re guaranteed a 15th consecutive quarterly deficit on the current account in the second quarter, putting Canada on track this year to top even last year’s massive current account deficit of C$48 bn. While the slowing global economy is hurting our exporters, so is an overvalued Canadian dollar. According to the IMF’s Purchasing Power Parity estimates, the loonie’s overvaluation is at its highest on records. While some would argue that PPP is a long term measure and isn’t really based on short term economic fundamentals, one can’t ignore the fact that it’s consistent with Canada’s external deficit, albeit with a lag.
Canadian dollar overvaluation worsens
Fundamentals tell a similar tale of loonie overvaluation. A model based on interest rate differentials with the US, and energy and non-energy commodity prices, puts the loonie much weaker than 1.05 C$/US$ in Q3, quite a departure from the current heady levels near parity. That’s primarily due to slumping commodity prices which,
as today’s Hot Charts show, haven’t been reflected in the loonie’s path lately. All told, the C$ seems to be punching above its weight at the moment and we expect it to succumb to gravity sooner rather than later. We, accordingly, remain comfortable with our call for the C$ to depreciate to 1.05 C$/US$ by year end.

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