Loonie up sharply as eurozone defence package restores confidence

The loonie joined several other currencies in rebounding sharply against the U.S. dollar Monday on the strength of a massive defence package for the euro worked out on the weekend.

TORONTO — The loonie joined several other currencies in rebounding sharply against the U.S. dollar Monday on the strength of a massive defence package for the euro worked out on the weekend.

The Canadian dollar soared 1.83 cents to close at 97.63 cents US in what economists expect will continue to be a slow — and occasionally halting — march back towards parity with the U.S. currency. At one point on Monday, it was up 2.14 cents at 97.94 US before falling back.

“I do think we will eventually head back to parity and maybe slightly above it,” David Watt, senior currency analyst at RBC Capital Markets, said in an interview.

“But … between now and then a lot has to happen in regard to this crisis ebbing,” he said, referring to market volatility caused by the government debt crisis involving Greece and several other European countries.

The European Union went a long way toward dealing with that crisis on the weekend when it joined with the International Monetary Fund in pledging a nearly US$1- trillion defence package for the embattled euro. The European Central Bank also announced it would intervene in bond markets as part of the wider effort to snuff out the continent’s debt crisis.

The aim is to turn back relentless attacks on the eurozone’s weakest members and allow the continent to resume its hesitant economic recovery and, by extension, reduce concerns for the global economy.

The euro responded strongly in early trading, hitting almost $1.31 US before trailing off and closing the day with a more modest gain of 0.56 of a cent at $1.2792 US. Meanwhile, the euro continued its ongoing decline against the loonie, falling another 1.91 cents to C$1.3103 Monday.

Doubts about the EU’s ability and commitment to solve the debt crises had sent equity markets tumbling last week and resulted in investors dumping other currencies in favour of the perceived safe haven of the U.S. dollar.

The loonie, which regained parity with the U.S. dollar in early April for the first time in 20 months, plunged to as low as 93.02 cents in hectic trading Thursday before recovering somewhat to just under 95.8 cents US by Friday.

Federal Finance Minister Jim Flaherty, speaking during a visit to Halifax, said the government was mindful of the big fluctuations in the Canadian dollar in recent days because of “various market changes.”

“There was some fairly rapid downward move last week —related to the European situation, no doubt. And that, having been addressed over the weekend, there has been some positive response to that,” Flaherty said.

Watt said what happened last week was a spike in risk aversion among investors as a result of the ongoing eurozone debt crisis.

“Everybody made a mad scramble for the U.S. dollar and that caused basically all currencies to weaken against the U.S. dollar,” he said. “So this weekend’s events have basically choked off that process.”

But Watt said a lot now depends on whether investors are confident enough to go back into equities to a great degree and into currencies like the Canadian dollar.

Mindful of past episodes, “people are going to be very wary until they get confident that things have definitively turned around and that…might not appear for a couple of weeks.”

Meanwhile, Watt said RBC is still looking for the loonie to hit parity by the end of June or early July, especially if the Bank of Canada begins to raise interest rates by then.

“But again, it is one of those situations, for that to happen confidence has to return to markets and, to the extent that we get ongoing turmoil over the next couple of weeks, we will probably hang up somewhat below parity until that begins to occur,” he said.

“It doesn’t mean things have to get perfect in the eurozone, just that this crisis has to ebb.”

Watt said the continuing strength of the Canadian economy “seems to suggest that the Bank of Canada cannot leave rates near zero that much longer.”

“But global events suggest we could be in an environment where cash or liquidity is hard to get. The Bank of Canada won’t want to increase rates to a great degree in an environment where liquidity is already tight,” he said.

In the long term, RBC economists believe the loonie will hit parity and could trade as high as $1.02 US by no later than the third quarter as the Bank of Canada starts to raise interest rates. They then expect it to slip back under a dollar — perhaps as low as 95 cents — once the Federal Reserve Board begins to raise interest rates in the U.S.

“But a lot of those (predictions) are conditional on the global economic outlook unfolding in a relatively optimistic way,” Watt said.

“Events of the past couple of weeks — they don’t necessarily destroy that outlook — but they certainly make it much more of a challenging outlook then it was a month and a half ago.”