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Foreign Exchange for Expats in Canada

Submitted: September 2013

The official currency in Canada is the Canadian dollar (CAD). It is also referred to as "loonie" or "piastre" in North American French. The Bank of Canada (BoC) is responsible for monetary policy.

Exchange rate regime

The Canadian dollar follows a purely freely floating exchange rate regime. There is no exchange rate target. The BoC doesn’t intervene in foreign exchange markets, except for countering short-term FX volatility.

From a historical perspective, Canada has regularly changed its exchange rate regime. Today’s free float has been in place since September 1998. Prior to September 1998, the Canadian dollar followed a managed exchange rate regime.

Monetary policy

Canada adopted inflation-targeting in 1991, with an inflation target (both CPI and core CPI) of 2% per year. "Inflation" specifically excludes asset prices, such as property or securities.

Inflation may be allowed to temporarily deviate from the 2% target, but by no more than 1%. Consequently, Canadian inflation may range between 1% and 3%. By "temporarily", it is generally understood 18 to 24 months.

When the BoC decides to tighten monetary policy (e.g. when inflation is too high), liquidity dries up, interest rates rise and inflation may go down. If the BoC wishes to loosen monetary policy (e.g. when Canada suffers economic slack), liquidity flows into the market, interest rates and borrowing costs decline, but inflation may rise.

Higher interest rates, whether expected or actual, tend to drive down securities prices. See Investment for Expats in Canada.

Current trends

The Canadian dollar is an expensive currency. Life in Canada may thus seem quite pricey for expatriates with foreign-source income.

Since the 2008 financial crisis, the BoC has held the central bank interest rate ("key interest rate") at very low levels. The key interest rate was initially shrunk to 0.25%. However, Canada’s commodity-driven economy has shown stronger recovery than its other G7 counterparts. As a result, the BoC decided to raise the key interest rate to 1% in summer 2010. This macroeconomic context has certainly contributed to persistent Canadian dollar strength since 2009.

Relation with the US

It is dangerous to claim that the USD/CAD exchange rate cannot move much either way. Both Canada and the US are developed countries, indeed. Yet, their macroeconomic fundamentals may diverge strongly. For instance, the US dollar was subject to intense upward pressure during the dotcom boom in the 1980s/1990s whereas Canada didn’t jump on the wagon at the time. Likewise, the US allowed a tremendous mortgage boom in the 2000s while Canadian banks kept conservative lending practices.

As mentioned above, today’s exchange rate (USD/CAD close to parity) is supposed to reflect Canada’s relative resilience as compared with the US or Europe. This situation may or may not last for a while, but it would be unsafe to assume it will last indefinitely. Remember that the US dollar was around 30% stronger when the US economy did well in the late 1990s.

 

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