[DanRath]

As the BoC gets ready to meet on Thursday, June 4 one wonders what they are thinking with regard to USD/CAD. Oil prices have increased since the April MPR consistent with some CAD bullishness. However, oil price increases have been rather modest. Meantime, USD/CAD has tumbled to levels last seen when oil prices were consistently above US$100/b.

Heading into the June 4 BoC fixed (in)action date it would appear that USD/CAD has moved much farther than underlying fundamentals (oil prices) would suggest is appropriate. In October 2007 the BoC noted a downside risk to the inflation projection "if the Canadian dollar exchange rate were to persist above the 98 cent U.S. level assumed over the projection horizon for reasons not associated with stronger-than-projected demand for Canadian products, Canadian output and inflation would be lower."

In the January MPR Update the BoC presumed with regard to the Canadian economic outlook that "support will also be provided from the past depreciation of the Canadian dollar." The mechanism, as straightforwardly expressed in the April MPR was through net trade — "exports are also expected to recover in response to the gradual improvement in external demand and the past depreciation of the Canadian dollar." The April MPR noted that USD/CAD had traded in a range of 1.2050 to 1.3000, and was basically unchanged since January.

Recent developments in USD/CAD could notable impact the BoC's outlook if they persist. In particular, net exports might not aid the recovery. Consider an alternative scenario — USD/CAD goes to parity by year end 2009 with a consistent sell off through mid-2010. In that scenario, the current net trade outlook is at serious risk, and the beneficial impact of past appreciation of the Canadian dollar gets blown to smithereens.