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Overview, Knowing the Canadian Dollar, How to read the Canadian Economy

Overview of the Canadian Economy

The Canadian economy primarily comprises of 3 sectors; namely
- Services
- Natural Resources
- Manufacturing.

Though Canada is known to the world for the abundance of Gold, Paper pulp and so on, it is the Services sector which dominates the Canadian economy today. While the Natural Resources sector & Manufacturing dominate the exports, the Services sector caters to the domestic economy of Canada. Canada is 14th in the World Oil production rankings, and fluctuations in the world oil rates tend to influence the Canadian dollar in a big way.

The fortunes of the Canadian Dollar are closely interwoven with the US Dollar. Exports to the US comprise more than 82% of the total exports from Canada. This is facilitated by Free Trade Agreement between the US & Canada, the formation of which gave a major boost to the Canadian economy as a whole. Not only the US, but Mexico is also included in the purview of this Agreement (for entire North America) and all the three countries stand to gain as a result. Japan & UK are the other major trading partners for Canada.

In terms of GDP, Canada is ranked 12th in the world and accounts for about US$1.08 Trl (2005). On the world map, it is ranked as the 7th largest country, which explains its potential with regard to Natural resources.

Regulatory Authority - The Bank of Canada

The Bank of Canada is the regulatory body, which frames & implements the monetary policy of Canada. The bank has two administrative wings - a Governing Council & the Board of Directors. The Governing Council comprises of the Governor, Senior Deputy Governor and four Deputy Governors. It is responsible for setting the monetary policy & steering the Canadian economy as a whole. The Board of Directors is primarily concerned with the governance of the bank - issues with the administration and management of the bank. It consists of 12 directors from outside the bank in addition to the Governor, Senior deputy governor and the Deputy Minister of Finance (as Ex-officio member without voting rights).

The main function of the Bank of Canada is to 'maintain the integrity & value of the currency'. The bank achieves that by keeping the inflation strictly under control. In order to have a sustainable long-term economic growth, a band of 1% to 3% has been set as the healthy inflation range. The bank continuously monitors the economy for any signs of crossing these limits and accordingly changes the short-term interest rates to ensure that the inflation is kept within the desired band. For example, it the inflation rate exceeds 3%, the bank would increase the interest rates; whereas it would decrease the interest rates if it falls below 1%. While changes in the interest rates are made on 8 different (predetermined) days in a year by the Governing Council, the target inflation range is revised every 5 years, in consultation with the Department of Finance.

Coming to the Exchange rate, which is of more interest to a Forex professional, it has been observed that any change in the interest rate would surely alter the CAD$ Exchange rate as well. Historically it has been found that the percentage change in interest rates and percentage change in Exchange rates are related by a ratio of 1:3 in Canada. In simpler terms this means that a 3% change in Exchange rate is brought about by a 1% change in interest rate. An important point to be noted here, is that the Bank of Canada does not directly alter the interest rates to control the appreciation or depreciation of the CAD$. As a matter of fact, the bank alters it only to control inflation. Consequently, this can lead to the appreciation/depreciation of the CAD$ (indirect, unintended effect). This is because the Exchange rate would have changed in proportion to the change in the interest rate, as indicated in the beginning of this paragraph.

Economic Updates

One needs to look out for Biannual Monetary Policy Report from the Bank of Canada to keep abreast of the latest economic scenario in Canada. Particularly, it throws light on the existing inflationary conditions and the countermeasures that are likely to be taken. Another important publication from the Bank of Canada is the 'Quarterly Bank of Canada Review' which contains views of the members of the Governing council, and related articles & commentaries.

The Bank of Canada uses the following methods to alter the monetary policy from time to time:

The Bank Rate

As was indicated earlier, the Bank of Canada alters the bank rate to control inflation. It affects the entire borrowing & lending operations of all banks in Canada, including mortgage also. Hence this is found to be the most effective means of controlling inflation as it percolates down into the entire economy.

Overnight Rate

The term 'Overnight' originates from 'Overnight Loans'. 'Overnight Loans' are the loans issued overnight by commercial banks in Canada to other banks to fund their daily transactions. These loans are worth large amounts and are transacted between Canadian banks over an electronic platform called 'Large Value Transfer System' or LVTS in short. The interest rates charged for the 'Overnight loans' are called 'Overnight Rates' or 'Cash Rates'. Typically, the Overnight Rate stands 50 basis points below the Bank Rate. The Bank of Canada changes the Overnight Rate by lending to the commercial banks at rates lower or higher than the existing Overnight Rate. Again, this is done to steer the economy in the right direction, and is also called as 'Market Intervention' by the bank.

Overview, Knowing the Canadian Dollar, How to read the Canadian Economy

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