Canada’s weak dollar may be good news for foreign capital but bad news for the cost of living. The loonie has plunged against the US dollar in recent months, and it’s unlikely to improve soon. Currency weakness has been a blow to manufacturers of complex and expensive goods like housing, which have seen input costs rise despite falling CPI. At least one Big Six bank sees the loonie extending its weakness with little relief in sight. That’s bad news for homebuilders, and the cost of living in general—even if CPI methodology fails to reflect this shift.
A Weaker Loonie Provides Benefits, But Not Always
A weak loonie is often touted as a benefit from policymakers, but that’s not always the case. Weak currencies tend to boost foreign investment, tourism, and exports. Some notable examples have been the boost to the film industry and the rise of big tech offices that have been able to score top talent at a steep discount. It also tends to require easier monetary policy, boosting consumer and business leverage, which can also be categorized as a negative.
However, weak currencies and more leverage aren’t a free ride. The leverage tends to skew affordability when it comes to real estate, as many folks have come to realize. It can also lead to a higher cost of living, since most commodities are priced in US dollars. Gasoline, lumber, aluminum, wheat, canola, etc. may be produced in Canada, but a global market means domestic demand competes with foreign demand that pays US dollars.
Even if commodity prices stop rising in US dollars, an eroding loonie means higher costs. That may not be reflected in CPI, which includes circular logic such as mortgage interest rates, unlike most other economies. Even if a CPI methodology is used that chronically underreports inflation, households still feel this cost escalation.
That’s a big problem when manufacturing large and complex goods like cars, and housing in Canada. As commodity and import costs rise, so does the cost of producing goods. Building more homes places more demand on rising material costs, making it more expensive to build homes. This partially explains the canceled projects, even beyond a lack of demand. None of this is a surprise to policymakers; they just won’t say it in public.
A weak loonie has been a major contributor to higher home-building costs. Despite CPI readings showing a weak currency, annual residential building costs rose 6.0% in Q3, about 3x the target inflation rate. The currency weakness is expected to linger over the near term.
Canadian Dollar To Remain Weak Against The US Dollar
Don’t expect a quick bounce for the loonie against the US dollar, warns BMO. The unemployment rate tends to be an important sign of economic strength, currently eroding much faster here. Canada’s unemployment rate is 2.6 points above the US (6.8% vs 4.2%). “Aside from a couple episodes during the wildness of the pandemic years, that’s the widest gap on the downside for Canada since 2001,” explains Douglas Porter, chief economist at BMO.
Adding, “…this gap serves as a leading indicator for the Canadian dollar.”
The bank found a strong correlation between the unemployment gap and currency strength. The loonie demonstrates more weakness as the US unemployment rate falls below Canada. The chart above shows the American unemployment rate has been lower since 2016, and the loonie has deteriorated fairly closely.
He emphasized two takeaways, “[First:] The unemployment rate gap tends to lead the currency by 6-12 months, suggesting the loonie will remain soggy for some time yet.”
Second, much of the damage is already priced in. “…it appears that the currency has already taken a lot of the tough news on board, likely further pressured by the prospect of U.S. protectionist actions in coming years,” he explains.
The point of tariffs is also worth considering in the context of a weak currency here. As mentioned, the primary benefit of a weak currency is attracting jobs created by foreign capital looking for a discount. If higher tariffs are imposed and the U.S. provides more domestic incentives to remain on-shore, Canada may not get the job creation boost it historically received.
In short, the currency’s weakness is forecast to extend with little relief on the way. Ironically, government spending on “affordability” can worsen currency problems. Exchange is influenced by money supply, and excessive expansion or a failure to contract when needed grows or extends that weakness. That isn’t to say that government spending is bad, but higher-impact spending needs to be balanced with low-impact spending for retail politics.
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