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Updated June 2020

Figure 1.9 shows the U.S./Canadian dollar exchange rates.

Summary

In 2019, the U.S./Canadian dollar exchange rate averaged US$0.75, about 3 per cent lower than 2018.

As Canada's economy is supported by activity in the energy sector, which is driven by strong oil prices, the exchange rate is projected to be sensitive to the near-term forecast price of oil before stabilizing at US$0.82 between 2022 and 2028. As oil prices increase over the forecast period, exchange rates are expected to improve from US$0.72 in 2020 to US$0.80 towards the end of the forecast.

In 2019

The Canadian dollar in 2019 depreciated 3 per cent relative to the U.S. dollar, decreasing from US$0.78 in 2018 to US$0.75. Beyond energy prices, Canada's exchange rate can also be affected by monetary policy and other macroeconomic factors.

The Bank of Canada last raised the overnight rate in October 2018, which is the rate at which major Canadian financial institutions borrow and lend one-day funds among themselves. The Bank of Canada previously raised its target for the overnight rate 3 times in 2018 as it sought to tighten the credit market. The rate ended 2019 at 1.75 per cent, which remained unchanged throughout the year.

Although the Canadian economy had been on target with its inflation rate at the end of 2019, the coronavirus disease (COVID-19) pandemic has negatively affected the Canadian and global economies. As a result of the virus's effects on global economies and in line with other central banks, the Bank of Canada lowered its overnight rate to 1.25 per cent in early March 2020, followed by another cut to 0.75 per cent in mid-March, and then 0.25 per cent at the end of the month. The Bank of Canada will continue to monitor the ever-evolving situation to ensure the economy is stabilized and inflation is kept within targets.

Similar to Canada and its concerns regarding trade and global demand, the United States ended 2019 with its interest rate target range between 1.50 and 1.75 per cent, which has since been lowered to a band of 0 and 0.25 per cent as of mid-March 2020. This contrasts with consistent rate increases in 2018, which finished that year between 2.25 and 2.50 per cent.

A significant development in 2018 was that Canada, the United States, and Mexico officially signed a new trilateral trade deal at the G20 summit. The deal replaced the North American Free Trade Agreement (NAFTA) with the United States – Mexico – Canada Agreement (USMCA). Although the USMCA was signed by all three parties in November 2018, it was not until March 2020 that all of the countries had ratified the agreement.

Forecast for 2019 to 2028

Over the forecast period, gradual interest rate increases are anticipated by both the Bank of Canada and the U.S. Federal Reserve, with the Bank of Canada targeting an inflation rate target of two per cent. Additionally, an increase in the interest rate would attract capital to Canada and appreciate the Canadian dollar. However, these rate increases are expected to be tempered by concerns for economic growth and recessionary risks.

Consistent with other major economies, weaker global economic outlooks and lower commodity prices have weighed on Canadian growth projections for 2020. As a result, Canada's exchange rate is forecast to decrease to US$0.72 in 2020. This near-term outlook is limited by several uncertainties, including

  • global trade tensions and slower economic growth,
  • domestic manufacturing and exported products,
  • oil inventory build-ups and production cuts, and
  • employment rates, housing demand, and consumption levels.

As commodity prices improve and stabilize, the exchange rate forecast is expected to follow similar trends. Over the remainder of the ten-year forecast period, the exchange rate is forecast to increase to US$0.74 in 2021 and US$0.76 by 2022, gradually improving to US$0.80 by 2029. Canadian energy exports are expected to rise over the forecast period with incremental export projects, including pipeline and LNG projects.

As Canada's exchange rate tends to be correlated with energy prices, the exchange rate is projected to improve after 2020. This increase is consistent with trends in Alberta's energy sector investment and exports. These improvements are associated with additional takeaway capacity in the form of rail service and pipeline expansions.

Market uncertainty in the energy sector will persist due to the recent destruction of demand, transportation challenges, and other government policy interventions. Other factors such as sustained macroeconomic effects due to the COVID-19 virus, further U.S. tax cuts, and worsening global economic indicators could further affect Canada's exchange rate.

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