Speculation the loonie may fly higher

May 24, 2008 Julian Beltrame The Canadian Press

Is the Canadian loonie preparing to take flight again?

While betting on the up and down movements of a currency is risky, some economists are beginning to move off their bearish outlook for the Canadian dollar and contemplating that the loonie may be readying a move to higher ground, well above parity.

"One could make the case that the loonie is undervalued at today's oil prices,'' says Bank of Montreal deputy chief economist Douglas Porter. "Partly, this likely reflects the fact that the foreign exchange market, for one, simply doesn't believe today's oil prices will last.

"Another factor may have also been that the Bank of Canada may cut (interest rates) further, but the U.S. Federal Reserve looks done,'' he added.

For several years, the Canadian dollar has generally moved in tandem with prices of commodities Canada has in abundance, particularly oil.

But the Canadian dollar hasn't gathered much strength during the surge from $95 US oil at the end of 2007, Porter noted. It only moved past parity with the U.S. currency when oil cracked the $130 level this week.

A good sign for the loonie's prospects was Scotiabank's commodities report Thursday that forecast crude oil prices in the $135 to $140 range for the rest of the decade, based on a shortage of new non-OPEC production and rising demand from emerging economies in Asia.

Scotiabank currency analyst Stephen Malyon said the bank is forecasting the loonie to finish the year at $1.01 US and 2009 at $1.06, but said it will likely revise the forecast upward next week on the growing perception that high oil and high commodity prices are here to stay.

"I think the Canadian dollar has a lot of things going for it, from a structurally sound economy, and the fact we're a commodity exporter amid a cyclical bull market in commodities,'' he said.

Of course, there are other factors that have come into play in the relative pricing of the loonie.

The Canadian dollar is directly impacted by the interest rate spread between Canada and United States and was lifted last fall when the Fed moved aggressively to cut rates in expectation of a serious economic slowdown.

As important is recent language coming from both central banks which suggests the Fed is heading for the sidelines, while the Canadian bank remains on an easing trend.

There is also the relative purchasing power of both currencies, which suggests that the loonie remains the weaker sister.