The Canadian dollar just fell below 75 cents U.S., its lowest level in two years — here’s why

The Canadian dollar fell to its lowest level in almost two years Tuesday - closing at 74.82 cents U.S. - as the economy struggles to absorb high inflation and faces a possible global recession.

The weakening Canadian dollar is tied to the U.S. federal reserve continuously hiking its key overnight lending rate to curb inflation. Relentlessly high inflation in the U.S. has the country's central bank raising rates aggressively, with a three-quarter percentage point hike expected on Sept. 21.

The U.S.'s policy interest rate, which allows the central bank to influence short-term interest rates, could rise to at least 3.25 per cent with some analysts expecting the policy rate to reach 4.5 per cent next year. This is higher than where the Bank of Canada is expected to take rates, widening the gap between the two country's currencies.

The catalyst for the weakening Canadian dollar is core inflationary pressure that we're seeing in the U.S.," said Bipan Rai, foreign exchange analyst with CIBC. We're expecting at least an increase of 75 basis points from the federal reserve tomorrow, with hikes continuing to an uncertain date. Because of the economic uncertainty the hikes are creating, the Canadian dollar will be impacted."

Over the last year, the Canadian dollar has been gradually sliding in comparison to a very strong" U.S. dollar, said Shaun Osborne, foreign exchange analyst with Scotiabank.

Generally, higher interest rates cause a country's currency to rise attracting foreign investment and heightening the demand for a country's currency. Because of this, the U.S. is a currency haven" often one of the strongest currencies globally, Osborne said. While positive for the U.S., Canada ends up living in its neighbour's shadow. Also comparatively the Canadian economy is much smaller, he added.

Unlike the U.S. dollar, the Canadian dollar is tied more to commodities such as oil. Typically, when oil prices rise the Canadian dollar strengthens - the dollar is reliant on the sale of crude oil to the U.S. However, this year, when oil prices skyrocketed to more than $100 a barrel, the Canadian dollar continued to slip.

The reason isn't fully known, said Osborne, but less investment in the oil sector and the greenification of the country's economy could both be factors.

Because the Canadian dollar is also tied to economic growth, the impending global recession paints a less rosy picture for the country's currency, said Adam Button, chief currency analyst with foreign exchange firm ForexLive.

Our currency is growth sensitive, and is closely tied to our resources which we export," he said. If the global economy weakens and underperforms that's reflected in our currency."

While the Canadian dollar has dropped, it's done comparatively well compared to the euro, British pound, and Japanese yen. For example, in the last year, the Japanese yen dropped by almost 25 per cent making the currency much weaker, whereas the Canadian dollar dropped by four per cent during the same time period.

The Canadian dollar has held up relatively well as the Bank of Canada has been more aggressive in it's rate hikes compared to Japan and Europe," said Scotiabank's Osborne. They've come late to the rate tightening party."

Since 2015, the Canadian dollar has ranged from 68 cents U.S. to 83 cents U.S. and it's now drifting back to the middle of that range, Osborne said.

Right now, analysts aren't concerned about the Canadian dollar's drop as its in line with historical trends. But if the federal reserve keeps hiking rates, beyond Bank of Canada rate hikes, more money will pour into the U.S. which could result in a weaker Canadian dollar, dipping below 73 cents U.S. by the end of the year, Button said.

Canada's economy will take a hit when trading with the U.S. as exported goods will be less expensive for the U.S. to sell and Canadian importers will struggle as prices are pushed upward.

For now, Canadians won't feel the pinch of a weaker exchange, accept when travelling to the U.S.

It will be cheaper to go to the eurozone for the next few months instead," Osborne said.

Clarrie Feinstein is a Toronto-based staff reporter for the Star. Reach Clarrie via email: clarriefeinstein@torstar.ca