Innovation

Canadian and Australian dollars diverge

Written by Stephen Poloz

The Canadian and Australian dollars have historically behaved in broadly similar fashion. But they have diverged recently, providing an insight into how the global economy is behaving.

Canada and Australia have much in common. With regard to the economy, though, a key shared characteristic is that production and exporting of resource products is important to both countries. This has traditionally caused the two currencies to be correlated with one another and with the global commodity price cycle. For example, when the global economy is in an upswing commodity prices rise, thereby making Australian and Canadian resource exports more valuable, and both currencies tend to appreciate.

To illustrate, consider a bit of history. The world economy boomed in the late 1980s and commodity prices rose. This pushed the Australian dollar up to nearly 90 U.S. cents in 1989 from a low of around 60 cents in 1986. During the same period, the Canadian dollar rose from around 70 cents to about 85 cents. Then, during 1997-2001, when the global economy weakened, the Aussie fell from 80 cents to about 50 cents, while the loonie fell from 75 cents to 62 cents.

The global recovery during 2002-03 helped push the Aussie back to around 70 cents, and during 2004 it fluctuated in the mid-high 70s. The Canadian dollar’s behaviour during the same period was very similar, as it appreciated from 62 cents back up into the mid 70s in 2003 and then fluctuated in the mid-high 70s during most of 2004.

Since late-2004, though, the story has changed. The loonie has spent most of the time above the 80 cent level, and during May-August has demonstrated a see-saw uptrend. In contrast, the Aussie has been edging lower, particularly during the May-August period.

The reason? In a word, oil. In recent months, the Canadian dollar has emerged as a petrocurrency, positively correlated with the price of oil. The global economy appears poised to shift to a slightly slower growth track, and most commodity prices have begun to plateau as a result, consistent with the flat-to-softening track of the Australian dollar. Yet oil prices have more than doubled since the end of 2003, rising in a straight line except for a brief pause in late-2004.

This wedge between the two currencies reflects a gradual increase in the importance of oil production to the Canadian economy. In 2004, Canada produced 40% more oil than it consumed, exporting the remainder. Canada also produced six times as much oil as Australia. Meanwhile, Australia consumed about 60% more oil than it produced, importing the remainder.

The bottom line? Higher oil prices are driving a wedge between the Australian and Canadian dollars. Assuming that oil prices ease in coming months, look for the traditional relationship to re-emerge, with the Canadian dollar easing and the Aussie regaining some of its lost ground.

August 24, 2005

The views expressed here are those of the author, and not necessarily of Export Development Canada.

Originally appeared on PROFITguide.com