Source: The Canadian Press

Although Canada’s economy may be the strongest in the industrial world and it’s fiscal position envied by larger economies in the U.S. and Europe, the country’s currency has underperformed this year.

And, of late, the loonie has been losing ground, down almost three cents in the past week and closing at 93.90 cents US on Monday.

As the year began, the vast majority of analysts believed the dollar would have at least reached parity by this time in the recovery cycle and, with the U.S. recovery progressing more slowly, would stay at that level for several years.

It may still happen, but the more likely course for the Canadian dollar in the second half of the year is now south, economists now say.

Royal Bank currency strategist David Watt says growing concerns over the sustainability of the global recovery, including fears of a double-dip recession, are worrying all markets, including commodity markets that influence the loonie.

“It suggests a lot of people are very concerned about what’s going on right now,” he explains.

“Until (the recovery) is clear, we think it’s tough for the Canadian dollar to face any notable rally.”

Watt says he would not be surprised the see the currency test the 92-cent floor during the current cycle.

The dollar parity story of a few months ago was based on the perception that after a deep recession, the world’s factories were gearing up to start churning out products again. That would spike demand for oil, base metals and other commodities which Canada has in abundance, and hence boost the loonie.

The story was unfolding as foretold as late as April, when the loonie did briefly reach parity with the U.S. greenback. But then came Europe’s debt crisis and, more importantly, growing fears that the global recovery was sputtering.

Even when the loonie was gaining, however, some economists never bought the parity story — notably Peter Hall, chief economist with Export Development Canada.

Hall says the loonie’s current level is not a product of extraordinary circumstances, but a reflection of its true fundamental value. In fact, his prediction is for the currency to drop to the 90-to-92-cent US level by year’s end.

His reasoning is that oil and base metals were over-priced given the low global demand and were due for a correction, which is now occurring.

“Those who are very bullish about the Canadian dollar’s prospects going into the true recovery when it occurs is based on the fact the we are going to run into (oil) supply constraints almost immediately,” he said. “There might be some short-run disruptions, but we don’t believe it’s sustainable.”

Oil’s extraordinary price inflation to US$147 a barrel in July 2008 was smoke and mirrors speculation, believes Hall, and unlikely to occur again, and certainly not justified by supply and demand.

He points out that oil traded in a narrow band between US$20 and US$30 from 1986 to 2002, a length of time suggesting that the fundamental value of the commodity may be less than even the current price of about US$70 a barrel.

The other factors that go into his calculation of the loonie’s value are the differential in Canada and U.S. interest rates, and the strength of the greenback against global currencies.

A strong dollar is an indication the rest of the world thinks highly of the country’s economy, and benefits Canadians who travel abroad, or who buy imported consumer goods such as German and Japanese automobiles.

But it also promotes what Hall calls a “two-speed economy” that helps commodity exporters in Western Canada boom at the expense of manufacturers in Ontario and Quebec, whose products get priced out of foreign markets.

In an analysis issued by the C.D. Howe Institute on Monday, authors Philippe Bergevin and Colin Busby say that although commodity prices are paramount, the Bank of Canada’s interest rate policy could also dramatically impact the dollar’s value.

Canada’s central bank moved ahead of the U.S. last month by raising rates a quarter point, they note. If the bank were to increase the disparity with the U.S. by a full point, it could add seven cents to the loonie’s relative value, they say.

The report argues the dollar’s fundamental value is about 97 cents US, with the fundamentals justifying the loonie moving again toward parity as oil prices firm.

Hall also sees the loonie reaching parity on a sustainable basis one day, but given the slow crawl of the global economy, that could take years, he says.