European lovers. German Machinery Importers. Exporters to the United States. These, in principle, are the big Canadian winners from the current economic upheaval.
Posted at 6:30 a.m.
Because for an upheaval, it is quite one. Not only has inflation never been so high since the 1970s, but the gaps vary greatly between the so-called advanced countries.
This raises big questions: what will be the consequences of these distinct paths between Europe and America, or even Asia? Will soaring prices in Europe end up sinking our economy as well, or is it rather the other way around?
First, the observation. While the inflation rate is 7% in Canada, it is 10% in Germany and 14.5% in the Netherlands. France is doing better than the others this time, at 5.6%.
Is it here to last? According to the consensus of economists, countries with high inflation rates will not see the pace of prices fall as quickly as others in 2023, in general. In Canada, inflation should increase by “only” 3.6% in 2023, but it will be double in the United Kingdom (7%), reports the National Bank.
The sharp rise in prices, it is well known, is attributable to the expansionary policy of central banks during the pandemic. They flooded the economy with cheap capital — they printed money, as it were. So today, consumers and businesses have a lot of money, which stimulates the demand for goods and services more than the economy can produce. This imbalance drives prices up.
The outbreak is stronger in Europe due to the war in Ukraine, which has made oil and natural gas from Russia scarce. Added to these phenomena are labor shortages, which vary from country to country.
Faced with this situation, the central banks of Canada and the United States ended up raising their key interest rates significantly to slow the economy. The rate is now 3.25% in both countries and further increases are expected, especially in the United States.
Meanwhile, the European Central Bank (ECB) remained cautious, keeping its rate at 0.75%, likely due to the tougher economic situation in Europe.
The loon flies higher
These differences in monetary policies, combined with very different inflation on the two continents, quickly had an impact on exchange rates. Capital has migrated to the most attractive interest rates, driving up the currencies associated with it, especially the Canadian dollar.
For example, the euro, the pound sterling and the Swedish krona have lost 15% against the Canadian dollar since the start of 2021. During the same period, the Australian dollar has lost 10% against the loonie. As for the Japanese yen, it is in free fall (—24%).
Conversely, the US dollar and the Mexican peso have remained firm against the Canadian loonie, even climbing about 5% since mid-summer, after a period of relative stability during the previous year. The recent rise in the US dollar can be explained in particular by the Federal Reserve’s intentions to continue its rate hikes.
Nicolas Vincent, professor of macroeconomics at HEC Montreal, believes that the inflation rate differentials between Europe and North America will last for some time. He would be surprised if the situation lasted five years. “If the differences in inflation rates persist, we can expect the euro to continue to decline,” he explains.
This is not the first time that there has been such a gap between developed countries, notes Steven Ambler, professor of macroeconomics at the University of Quebec in Montreal. In the 1970s, inflation was under control in Germany, with rates of 3-4%, but out of control in Canada (up to 20%).
According to him, a high rate of inflation will eventually harm economies that are too lax. “The ECB let things go for too long. It could be dangerous,” says Mr. Ambler.
Impact on our economy
And what is the effect of this shock on our economy, in the end? In principle, Canadian importers should benefit from a strong loonie against overseas currencies. It should therefore cost less to buy machinery from Germany, for example.
But there is a catch: as prices rise in Germany and Europe, the rise of the loonie is canceled out, in a way. The advantage is therefore relative: goods imported from Europe will not cost more for Canadians, while the same goods will be more expensive for Europeans.
On the other hand, Canadian tourists could still find good opportunities in Europe, assuming they can find flights. Why ? Because price increases are not transmitted as quickly in wages and therefore in the service industry, such as tourism, explains Nicolas Vincent.
Conversely, the decline of the loonie against the American currency will favor our exporters of goods to the United States, such as our tourism businesses, which are mainly American-centric.
Hendrix Vachon, economist at Desjardins Group, however, tempers these findings. The labor shortage in Quebec and Canada will make it difficult to increase the supply of products to the United States.
In addition, US demand could deflate if there is a recession, as the stock markets, which are in sharp decline, are anticipating. Same constraint of offers and requests coming from Europe.
Not so simple, this upheaval…