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Greek debt crisis stalls loonie's expected flight to parity, for now

OTTAWA - The loonie's assault on parity with the U.S. dollar appears to have stalled — for now — amid a flight to safety from the spreading Greek contagion.

OTTAWA - The loonie's assault on parity with the U.S. dollar appears to have stalled — for now — amid a flight to safety from the spreading Greek contagion.

With the sovereign debt crisis threatening to metastasize across southern Europe, the Canadian currency is once again finding it difficult to stay aloft as investors flee to traditional safe-haven currencies, particularly the greenback.

The loonie fell for the second straight day Wednesday — at one time plunging close to a cent to a two-month bottom of 96.58 cents US — before recovering somewhat to 97.12 cents.

The loonie is performing well against the euro, however, having gained about two per cent so far this week.

The swoon against the U.S currency is reminiscent of a couple of years ago when the financial meltdown and ensuing economic collapse sent the loonie tumbling from near parity in September 2008 to about 77 cents US by the following March.

Economists don't expect the European crisis to precipitate such a deep fall-off this time, although they say the loonie could stay below par for some time.

Then as now, the trouble emanates from outside Canada's borders. And then, more than now, Canada would appear better cushioned from the fallout than most countries, including the United States.

And yet the loonie, which had been strong on good economic news, is falling on bad. Meanwhile, the exact opposite is occurring to the U.S. currency.

"It's just this knee-jerk reaction that the U.S. dollar and U.S. treasuries always seem to be the recipients of the flight to safety," said TD Bank chief economist Don Drummond.

"It's bizarre and probably perverse. If you are worried about debt, why wouldn't you move your money into Canada rather than the U.S.?"

As Finance Minister Jim Flaherty has repeatedly pointed out, Canada's fiscal positions is far superior to any country in the Group of Seven, with a debt to gross domestic product ratio slated to peak at around 35 per cent. That compares with 100 per cent and more for most G7 countries.

The U.S. debt to GDP ratio is already double Canada's and will almost certainly get worse over the next five or 10 years.

As well, Canada's economy outperformed the G7 in the recession and is expected to expand faster during the recovery.

"We are solid, we are a model for the world, quite frankly," Flaherty said Wednesday, "so it is not a direct threat to us."

RBC currency analyst Matthew Strauss says commodity currencies such as the Canadian dollar are taking the biggest hit. He explained markets are concerned that if the problems persist or get worse, they could stall a European recovery and slow global growth.

That impacts Canada because a slower recovery would depress demand and prices for oil and other commodities the country exports.

"It looks like sentiment is against the commodity currencies, so I would not be surprised to see CAD (the Canadian dollar) going (lower) in the near future before a retry at parity," Strauss said.

Economists also speculate the European sovereign debt problems pose a sufficient threat to the global economy to stay Bank of Canada governor Mark Carney's hand on raising interest rates, at least for now.

Carney had been widely expected to double the policy rate to 0.50 per cent on June 1, still a very low rate, but many now believe the odds of the bank standing still in four weeks time have risen.

Both developments would be considered a net gain for the Canadian economy. A lower dollar is favoured by exporters because it makes their products more competitive in foreign markets, while low interest rates encourage spending and investments.

"To mainstreet Canada, if this leads to dollar depreciation and lower bond yields, then it might be a net-net stimulus to the economy," said Derek Holt, vice-president of economics with Scotia Capital.

Holt cautioned that the situation is still too fluid to predict, hence the skittish nature of markets, which have sold off equities all week.

Concerns have grown that Greece will be unable to comply with the aggressive austerity measures it has been forced to accept as part of a bail-out agreement, a sentiment supported by rioting in the streets. As well, markets fear other so-called PIIGS countries — Portugal, Italy, Ireland and Spain — face debt crisis of their own in the future.

The next immediate hurdle comes Friday when the German parliament votes on the US$145-billion support package for Greece. A rejection, said Holt, could set off panic in the financial markets, although he does not believe that will occur.

"My gut is this is a regional issue that will eventually get worked out," he said. "There's too much invested in making the euro work to lend credit to the argument there is a risk of booting countries out of the system."

 
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