Canada’s currency is overvalued by 10 per cent, say economists

OTTAWA—Canada’s loonie may have slid well below parity during the past few months, but it has room to fall further before reaching it’s true value at under US90 cents, according to a new measure on global currencies.

The latest World Price Index report issued by London-based World Economics says the loonie remains about 10 per cent overvalued despite a recent dip that has taken it from parity to just above 96 cents US.

That would mean the true value of the Canadian currency is under 88 cents US, lower than what many Canadian analysts calculate as the underlying value of the loonie.

But that doesn’t mean markets will react to the measure right away or even in the next few months, says Bank of Montreal chief economist Doug Porter, who believes the loonie’s underlying value may be just north of 90 cents.

The dollar ended the day’s trading at 96.34 cents US, down 24 cents from Friday’s close, as nervousness over the approaching debt ceiling deadline in Washington intensified.

World Economics calculates the relative value of currencies by measuring relative purchasing power and excludes temporary factors that tend to influence traders.

Coincidentally, the Bank of Montreal last week issued a price comparison between U.S. and Canada that also showed consumer items on average costing 10 per cent more north of the border, exactly what the World Economics measures would suggest.

The TD Bank earlier this year issued a forecast calling for the loonie to fall as low as 90 cents by the end of 2013.

Porter’s own projection is for a 95 cent loonie by year’s end, drifting lower toward 90 cents over the next few years.

He says his calculation looks at factors besides purchasing power, including world commodity prices, unit labour costs, relative productivity measures and trade.

“If your underlying trade deficit is quite large, it’s an indication something is askew with the value of your currency,” he said. “And if you are constantly dealing with an overvalued currency, those sectors in the economy affected by the exchange rate, like manufacturing and tourism, will struggle.”

Canada’s trade performance with the rest of the world has been in deficit for almost two years and widened to $1.3 billion in August.

The loonie is not alone in trading far from its fundamental value.

According to World Economics, France’s euro tops the list of overvalued major currencies at 28 per cent above it’s purchasing power, followed by Japans Yen, overvalued by 25.6 per cent, and Brazil at 22.5 per cent.

Germany is only marginally overvalued by 1.4 per cent, which the report notes “imposes great strains on some members of the currency union,” since other euro nations have wider gaps between the value of their currency and the actual purchasing power.

On the other side of the ledger, the organization says India has the largest undervaluation at 45.5 per cent, followed by Mexico (23.4 per cent), and China (12.9 per cent).