Canada’s economy hampered by troubled neighbor

September 8, 2011

By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Canada’s economic comfort is suffering at the hands of its troubled southern neighbor. The Bank of Canada on Wednesday stopped raising interest rates at 1 percent, largely because of deteriorating U.S. conditions. That’s a pity — Canada would benefit from rates above inflation. But sluggishness and policy wrangling south of the border sap growth and make the Loonie less competitive.

That makes the central bank’s decision understandable. Canadian short-term rates are already 1 percentage point higher than America’s zero rates, while the Canadian dollar has strengthened by 5 percent against the greenback in the past year. The prevailing near parity between the two currencies hurts Canadian exports, slows growth and hampers job creation, even though the country’s resources sectors remain competitive.

A pick-up in growth in the United States would help boost Canada’s exports, while higher U.S. interest rates would reduce the upward pressure on the Canadian dollar. But neither of those things is likely to happen in the short term, and the U.S. Federal Reserve’s commitment to a zero-rate policy through 2013 could even at some point put pressure on the Bank of Canada to reduce rates.

Yet Canadian inflation approached 3 percent in the year to July, and the nation’s savings rate, at 4.1 percent in the second quarter, is uncomfortably low — and has fallen by 2.7 percentage points in the past year. Higher rates could help on both counts. Increased savings could also help the government as it chips away at the budget deficit and tries to balance its books by 2013-14.

Not that inflation, let alone growth, can be said to be overheating. But that, like the Bank of Canada’s rates policy, has a lot to do with the cold wind from the south. The United States represented 73 percent of exports in 2010, and the hobbled EU and Japan a further 12 percent.

A push to build closer ties with faster-growing developing countries could help long term. Location makes that diversification challenging and, if a U.S. diplomatic cable published by Wikleaks is to be believed, Prime Minister Stephen Harper’s foreign travel — for instance to Brazil last month — isn’t especially to his liking. But it’s a worthy goal. In the meantime, Canada’s erstwhile geographical advantage is, for now, its millstone.

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