The Bank of Canada and the Government of Canada were amongst the most aggressive in their stimulus programs. Central banks and governments around the world have already started pulling back on the huge monetary and fiscal stimulus which was designed to address the economic stoppages resulting from the pandemic. Generally, a more inflationary environment will mean a lower the Canadian dollar. Given Canada’s open economy, US inflation will invariably be imported into Canada. But inflation figures have consistently surprised to the upside and proven more persistent than some anticipated. So far, central banks have generally dismissed inflation as transitory and not a reason to pull back on stimulus sooner-than-expected. Inflationary pressures have surfaced on both sides of the border in the last few months. The more robust the economic recovery the higher the Canadian dollar. What remains to be seen now is whether the acceleration of economic activity will continue or whether we are in for a long slog for the last mile of recovery.
Indeed, we have exceeded the most optimistic scenarios for economic recovery and the “reflation trade” has been a key theme to the financial markets for the last several months.
In almost all measures of economic activity, we are approaching, or are already, above pre-pandemic levels. Early on in the pandemic, the debate was about the shape of the recovery will it be a V-shaped or U-shaped recovery? That question has been definitively answered.
Here is what is now driving the value of the Canadian dollar. Similarly, the economic recovery in Canada and the US is quite advanced while it remains at various stages in other parts of the world. The risk of the virus is now receding in Canada, though it remains a potent challenge in much of the rest of the world. The defining social and economic event of the last year and a half has been the COVID-19 pandemic.
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