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Inflation and Currency | How will the global shock affect us?

European lovers. Machinery importers from Germany. Exporters to the United States. These, in principle, are the big Canadian winners from the current economic turmoil.

Posted at 6:30 am

Because for a disorder, it’s quite one. Not only has inflation never been this high since the 1970s, but the gaps vary widely among so-called advanced countries.

This raises big questions: what will be the consequences of these different paths between Europe and America, or even Asia? Will the rise in prices in Europe end up sinking our economy as well, or will it be the other way around?

First, the observation. While the inflation rate is 7% in Canada, it is 10% in Germany and 14.5% in the Netherlands. France is doing better than the others this time, with 5.6%.

Are you here to last? According to the consensus of economists, countries with high inflation rates will not see the pace of prices fall as fast as others in 2023, overall. In Canada, inflation should increase “only” 3.6% in 2023, but it will double in the United Kingdom (7%), reports the National Bank.

The sharp rise in prices, it is well known, is attributable to the expansionary policy of central banks during the pandemic. They flooded the economy with cheap capital: they printed money, so to speak. So today, consumers and businesses have a lot of money, which stimulates demand for goods and services beyond what the economy can produce. This imbalance drives up prices.

The outbreak is strongest in Europe due to the war in Ukraine, which has made Russia’s oil and natural gas scarce. Added to these phenomena is the shortage of labor, which varies from one country to another.

Faced with this situation, the central banks of Canada and the United States ended up significantly raising their key interest rates to slow down the economy. The rate is now 3.25% in both countries and further increases are expected, especially in the United States.

Meanwhile, the European Central Bank (ECB) remained cautious, keeping its rate at 0.75%, probably due to the more difficult economic situation in Europe.

The rascal flies higher

These differences in monetary policies, combined with very different inflation on the two continents, had a rapid impact on exchange rates. The capital has migrated to the most attractive interest rates, driving up the currencies associated with it, especially the Canadian dollar.

For example, the Euro, British Pound, and Swedish Krona have lost 15% against the Canadian dollar since the beginning of 2021. Over the same period, the Australian dollar has lost 10% against the Canadian dollar. As for the Japanese yen, it is in free fall (-24%).

By contrast, the US dollar and Mexican peso have held firm against the Canadian dollar, even rising around 5% since mid-summer, after a period of relative stability during the previous year. The recent rise in the US dollar is explained, in particular, by the Federal Reserve’s intentions to continue raising rates.

Nicolas Vincent, professor of macroeconomics at HEC Montreal, believes that inflation rate differentials between Europe and North America will last for some time. He would be surprised if the situation lasted five years. “If differences in inflation rates persist, we can expect the euro to continue falling,” he explains.

This is not the first time such a gap has existed between developed countries, notes Steven Ambler, a professor of macroeconomics at the University of Quebec in Montreal. In the 1970s, inflation was under control in Germany, with rates of 3-4%, but out of control in Canada (up to 20%).

According to him, a high rate of inflation will end up hurting economies that are too lax. “The ECB let things go too long. It could be dangerous,” says Mr. Ambler.

Impact on our economy

And what is the effect of this shock on our economy, in the end? In principle, Canadian importers should benefit from a strong Canadian dollar against foreign currencies. So it should cost less to buy machinery from Germany, for example.

But there’s a catch: As prices rise in Germany and Europe, the Canadian dollar’s rise cancels out, in a way. Therefore, the advantage is relative: imported goods from Europe will not cost more for Canadians, while the same goods will be more expensive for Europeans.

On the other hand, Canadian tourists could still find good opportunities in Europe, assuming they can find flights. Why ? Because price increases are not transmitted as quickly in wages and therefore in the service industry, such as tourism, explains Nicolás Vicente.

Conversely, the Canadian dollar’s decline against the US currency will favor our exporters of goods to the United States, such as our tourism businesses, which are primarily focused on the United States.

However, Hendrix Vachon, an economist at the Desjardins Group, tempers these findings. Labor shortages in Quebec and Canada will make it difficult to increase the supply of products to the United States.

In addition, US demand could deflate in the event of a recession, as anticipated by the stock markets, which are in sharp decline. Same restriction of offers and requests from Europe.

It’s not that simple, this disorder…

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