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Canadian Dollar Set to Hit Par Again – Impact on Interest Rates

Why Higher Dollar Means Bank of Canada Can Keep Interest Rates Unchanged

The Canadian dollar is on a tear, and some think that a correction is due, but over the longterm the CDN dollar is strong given the nature of the economy. Bank of Canada Governor Mark Carney has noted the trend but also considers it some good news if the Bank of Canada is going to fulfill their pledge to keep interest rates the same for another quarter.

So why is it a good thing that the dollar is high if you’re going to plan to keep interest rates the same?

Simply put, in a global economy the laws of supply and demand hold true for foreign currency trades just anything else. So think about it for a moment: if the interest increase, that means that short term investments will adjust accordingly, and thus investment into Canadian financial instruments look better compared to other countries. As such, you’d find an increase in demand for the CDN currency thereby driving up the price.

If the Canadian dollar is around par with the American Greenback, then keeping the interest rate unchanged won’t cause a short term jump in demand for CDN $. If the bank were to increase interest rates then you’d certainly see a spike in appreciation for the CDN $ vs. the USD $. Canadians would be paying less for American dollars, our exports would be more expensive, but we’d be able to import more.

So as it stands the Bank of Canada doesn’t mind the higher dollar as it gives another strong reason why they can keep the interest rate unchanged for at least another quarter.

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