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Canadian inflation data could nudge dollar close to parity this week

TORONTO - The latest inflation data could move the Canadian dollar even closer to parity with the U.S. dollar this week after a strong employment report Friday sent the loonie surging.

TORONTO - The latest inflation data could move the Canadian dollar even closer to parity with the U.S. dollar this week after a strong employment report Friday sent the loonie surging.

The currency ended the week at 98.2 cents U.S. and during the course of Friday trading came within about a cent and a half of parity - its highest level since July, 2008. The loonie hasn't been level with the greenback since May 2008.

The reason for the currency's latest runup was a better than expected Canadian employment report for February. Statistics Canada reported that 21,000 jobs were created last month, better than the 15,000 that had been expected by many economists. The unemployment rate fell to 8.2 per cent from 8.3 per cent.

The report served to further convince currency traders that the Bank of Canada will move to raise interest rates around mid-year.

And pressure on the dollar could build at the end of this week when the February Consumer Price Index is released.

"If we get a surprisingly high reading on that front, then expectations of Bank of Canada interest rates hikes will just build incredibly and that could be the trigger that pushes us through parity if that CPI report is higher than expected," said Doug Porter, deputy chief economist at BMO Capital Markets.

"It sounds a bit counterintuitive to see a strong inflation report being good for a currency, but that's the way currency markets read this at least over the short term is that strong inflation equals interest rate hikes which equals a more robust currency."

Porter observed that inflation has been on the high side recently.

"We're going to be particularly watching core inflation," he said, "If it stays close to two per cent, that's a dangerous signal for the Bank of Canada because at this very early stage of recovery to have inflation already at their target is a bit of a concern for them."

The higher dollar does have its compensations. Some imports become cheaper and for March break vacationers, the increased value of the Canadian dollar makes travel far less expensive than this time last year when the currency traded around 78.5 cents US.

That low paralleled stock markets, which were just beginning to recover from the depths of the financial crisis that sent markets to multi-year lows.

But it's another set of bad news for Canadian exporters who find themselves frustrated in making financial plans with a rapidly rising currency.

"And not just exporters - even manufacturers who service the domestic economy will face increased competitive pressure from a currency close to par," said Porter.

"Many have said, 'we've been to par before and we lived with it then, what's the big deal now?"'

"Well the big deal now is that the U.S. economy is just not the same place it was a few years ago, we're still dealing with very sluggish U.S. growth so that is going to impose a burden on Canadian companies."

The dollar is also being sent higher by rising commodity prices. Oil broke through the US$82 a barrel level last week for the first time since January and copper prices continue to increase on hopes for higher demand, primarily from China and other developing countries.

Meanwhile, stock markets could be in for another lacklustre week after putting in a flat performance last week.

But while the TSX drifted last week, that followed a sharp three per cent rise the previous week on solid earnings from the big Canadian banks and rising commodity prices.

"I would also point out that in February, the market popped five per cent," said Pat McHugh, senior portfolio manager at MFC Global Investment Management.

Still, the TSX has broken out above the 12,000 mark for the first time since September, 2008 when the financial crisis was going into high gear. The main index was trading above where it started the year last week by about 250 points.

And those grudging gains could likely be a feature of this year.

"Our take on 2010 is that people should be thinking of single digit returns, hopefully high single digits - but single digit returns," said McHugh.

McHugh looks at this year as a "a breather year" following a sharp 31 per cent gain on the TSX last year.

"We've had the huge move in 2009, interest rates will come up, things will slow down here in Canada for awhile," he said, but added he expects a much better year in 2011.

 
 
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