Major Factors Affecting The Value Of The Canadian Dollar

16th January, 2013
16th January, 2013
Amy Pereira
Foreign Exchange Project
Major Factors Affecting the Value of the Canadian Dollar
Mohani Sooklall
Banking & Finance
Amy Pereira
Foreign Exchange Project
Major Factors Affecting the Value of the Canadian Dollar
Mohani Sooklall
Banking & Finance

Mohani Sooklall 10th January, 2013
Interest Rates (Monetary Policy)
Interest rate is the rate at which interest is paid by borrowers for the use of money that they borrow from a lender.

The Bank of Canada can attempt to influence Canadian dollar exchange rates by manipulating the interest rates.
If the Bank of Canada wishes to stop a drop in the value of the Canadian dollar, they can raise interest rates higher than other nations. This in turn can spur investments in Canada rather than other countries causing a demand for the Canadian dollar due to the rise in higher interest rates allowing investors to gain.
If the Bank of Canada chooses to stop a rise in the value of the Canadian dollar; they will accomplish this by lowering interest rates below other nations, which in turn causes relatively lower investments because the Canadian dollar is decreasing.
The manipulation of interest rates is a very complex task. Changes in interest rates affect commercial interest rates (i.e. mortgages, consumer loans, deposits into financial institutions), asset prices (i.e. bonds, stocks, and houses), and exchange rates of the Canadian dollar and also the expectation of the future interest rates, economic growth and inflation.
The transmission process of increasing/decreasing interest rates takes time, although commercial rates, asset prices and exchange rates are affected quite quickly. However, it takes a period of time before interest rate changes influences spending & saving decisions in consumers.

Mohani Sooklall 10th January, 2013
Inflation
Inflation is the rate at which prices for goods and services rise over time. As inflation increase, the purchasing power of the dollar decreases.

The Bank of Canada aims in keeping inflation at the 2 percent mid-point of a target range of 1 to 3 percent.
Every modern economy experiences a certain level of inflation but businesses and investors prefer an economy with low and stable levels of inflation. This not only protects their investments from eroding in value but also predicts what their production cost will be over the long term (i.e. cost of equipment, new technology & labour). In turn, low inflation encourages companies and individuals to do business in the economy.
If inflation in the Canadian economy is higher than other countries, both the domestic and foreign investors will prefer to do business with other nations. This causes lower demand for the Canadian dollar and a downward pressure on its value in the international currency markets.
If inflation is low in Canada compared to other countries, it will spur investment dollars into Canada; increasing demand for the Canadian dollar which automatically increases its value.
To control inflation, the Bank of Canada purses inflation targets actively. This is done by manipulating interest rates and consumers spending habits.

Example:
In a situation where inflation is rising at higher levels,

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