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Canadian dollar on a roll

Globe and Mail Update

Ottawa — Ottawa's deficit has ballooned, the Canadian economy is about to register one of its worst quarters ever, and Statistics Canada announced the deepest current account deficit on record.

But the Canadian dollar does not care. The loonie gained nearly 2 cents Friday, winding up the month of May with an 8-cent runup against the greenback to almost 92 cents U.S., its highest level since early last October – and the biggest single-month showing since 1950.

“I can remember when the mere mention of a deficit for Canada would either get you laughed off stage or cause the loonie to plunge [or both] yet we're about to see the worst deficit on record and the currency is back above 90 cents,” said economist Andrew Pyle, a wealth adviser at Scotia McLeod. “Go figure.”

The Canadian dollar closed up 1.9 cents to 91.6 cents (U.S.), after going as high as 91.76 cents.

The current account deficit expanded to $9.1-billion in the first quarter of 2009, Statscan said Friday morning. It's the second-straight such deficit for Canada, after years of enjoying surplus status.

The current account is like the country's bank account with the world. A current account deficit means Canada is spending more than it earns.

An enormous drop in Canada's auto exports and energy income in the first quarter were the main forces behind the growing deficit. The plunge in export earnings was partly offset by a narrowing of the investment income deficit, Statscan said. Foreign direct investors' profits earned in Canada fell to the lowest level since 2004.

The first-quarter deficit is larger than the $7.8-billion deficit in the previous quarter, but is significantly small than the $10.3-billion deficit that economists had been expecting – giving currency traders yet another reason to buy the Canadian dollar.

The Canadian dollar is on a roll, mainly because the U.S. dollar is not. The American currency fell steeply Friday morning as signs of economic strength in Japan and India prompted some hope for a global recovery, while concerns about the U.S. ability to handle its mounting deficit remained.

India's economy grew by 5.8 per cent in the first quarter, while Japan's industrial production managed to expand 5.2 per cent in April compared to March. The news helped push the U.S. dollar to a five-month low against a basket of currencies, and the Canadian dollar went along for the ride.

Higher commodity prices are also buoying the Canadian dollar. Oil was up significantly on Friday morning, trading at more than $66 (U.S.) a barrel.

But the Canadian currency's strength is also a statement about the bad shape of the rest of the world, said Michael Gregory, senior economist at BMO Nesbitt Burns.

“Currency guys have to buy currency. They've got to buy something. And if everything looks bad, what looks least bad?” he said.

While the Canadian economy is still mired in recession and has a growing deficit, the deficit is not as big here as elsewhere, he explained. Plus, the Bank of Canada has not engaged in the currency-diluting process of quantitative easing, as some other major central banks have done.

“That looks like what sparked interest in the Canadian dollar,” said Mr. Gregory.

Indeed, the loonie has gained 11 per cent since the Bank of Canada announced in April that it would not be doing any quantitative easing for now.

And if the global economy looks like it is poised to recover, then commodity prices and Canada's economy will be the immediate beneficiaries of the rebound, Mr. Gregory added.

“The bottom line is, there are some positives about Canada. Our bads are less bad than everywhere else.”

In fact, however, the Canadian dollar has not gained as much against the U.S. dollar as other currencies such as Australia, New Zealand and Europe – suggesting there is some hesitation in fully embracing the loonie, said Mr. Pyle.

“Global investors are selling North America.”

While some currency forecasters expect a surge to parity, others believe the loonie may be getting a bit carried away right now, especially since the higher exchange rate will impose yet another burden on Canada's manufacturers and exporters, and could cut into overall growth.

But Canadians need to get used to a strong currency, said economist Dale Orr or Dale Orr Economic Insight.

Oil prices are likely to rise over time, and the relationship between the loonie and oil is tight, he said.

“Since Canada is a net oil exporter, the fundamental economic relationship calls for a higher price of oil to cause upside pressure on the Canadian dollar,” he said in a research paper. “However, a stronger Canadian dollar could act to restrain Canada's economy recovery.”

The high loonie has compounded the difficulties of exporters already suffering because of weak demand in the United States, economists say.

“That [the appreciation of the Canadian dollar] is not good news for any of us who are in the business of manufacturing goods for export, especially into the United States,” Jim Shepard, chief executive officer of Vancouver-based forest products company Canfor Corp., said in an interview this week.

Wednesday, Canfor said it would indefinitely close three of its sawmills in British Columbia as soon as existing log inventories are used up and finished products are shipped. About 570 employees will be affected by the decision.

With files from Virginia Galt

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