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The worst is coming for the loonie, says Canada’s biggest banks

The oil boom that powered Canada’s recovery from its 2009 recession is turning into a bust for the nation’s dollar.

Canada’s currency tumbled this month to a five-year low of 87.83 cents US as the price of oil, the country’s biggest export, fell 30 percent from a June peak. Without a sustained increase in crude, the local dollar will weaken at least another 4 percent to 84.75 cents US, according to Toronto-Dominion Bank and Royal Bank of Canada, the nation’s two biggest lenders.

“The risk is, a sustained push lower in oil prices cuts Canadian growth,” Shaun Osborne, the chief currency strategist at Toronto-Dominion, Canada’s largest bank, said by phone on Oct. 15. “Any sort of setback for growth and investment in the energy sector is likely to have a fairly significant knock-on effect for the rest of the economy.”

The slide in oil, caused by a combination of oversupply and falling global demand, is a setback for Canada. Since the recession, most new business investment and jobs have come from the oil-rich province of Alberta. The nation’s trade surplus turned into a deficit in August, and economic growth stalled the previous month.

Money managers are boosting bets the Canadian dollar will keep weakening. Hedge funds and other large speculators pushed net-bearish wagers on the currency to 16,167 contracts in the week ending Oct. 17, the most since June, according to the Commodity Futures Trading Commission in Washington. Investors held net-long positions as recently as Sept. 26.

LOONIE’S DECLINE

The loonie has fallen 5.5 percent versus the U.S. dollar this year, after sliding 6.6 percent in 2013. The currency traded at 88.96 cents US at 8:39 a.m. in London, after tumbling to 87.83 cents US on Oct. 15.

The median estimate of more than 40 strategists compiled by Bloomberg is for a more than 1 percent decline to 87.72 cents US by the middle of next year. RBC had predicted a drop to 84.75 cents US by the end of 2015 before the slide in oil prices, though now that it’s happening, the bank sees the currency falling even more.

“We’ve already been negative on the Canadian dollar, but that hasn’t really incorporated negative oil prices,” Greg T. Moore, a senior currency strategist at RBC in Toronto, said by phone on Oct. 17. “What’s been driving capital expenditure so far has been oil-based, oil-sands-focused.”

ENERGY ECONOMY

The North American rate against which Canadian oil grades are priced, West Texas Intermediate, slipped to $79.78 US a barrel on Oct. 16, dipping below $80 a barrel for the first time in more than two years. Brent crude, the international benchmark, sank to $82.60 the same day, the lowest since November 2010. Bank of America Corp. and BNP Paribas SA predict prices will hold above $80 a barrel.

A jump in oil prices earlier this year benefited Canada’s economy and its dollar, helping the nation recover from last year’s housing-market slump. Western Canadian crude output climbed almost 50 percent from 2005 to last year, data from the Canadian Association of Petroleum Producers show.

What had been a blessing is becoming a burden.

Brent prices are approaching levels at which Canada’s oil industry will cease to be profitable. The so-called break-even point for about 25 percent of the nation’s oil projects is $80 a barrel, according to an Oct. 14 report from the International Energy Agency.

LABOUR INTENSIVE

Extracting Canada’s heavy oil from Alberta sands is a more labour-intensive process than required for other grades.

A third of private-sector capital spending in Canada is tied to Alberta’s oil, according to RBC estimates. Production in the province is responsible for all of the country’s net- employment growth for the 12 months ending July, data compiled by Bloomberg show.

“Persistently lower-than-assumed oil prices” may have “a material impact on investment and activity in the oil sector,” the Bank of Canada said yesterday in its quarterly monetary policy report, after keeping its main interest rate at 1 percent. The economy won’t reach full output until the second half of 2016, according to the report.

Canada posted a $610 million ($542 million US) trade deficit in August that was foreseen by none of the 14 economists surveyed on the data by Bloomberg. The economy stagnated in July, after a second-quarter expansion led by exports.

Canada’s currency will depreciate to 85.47 cents U.S. next year and may weaken to 76.92 cents US in the longer term as slower growth pushes up unemployment, according to Toronto-based Sprott Asset Management LP, which oversees $7.5 billion.

“We’re a commodity currency, so the currency gets crushed” as raw materials drop, Michael Craig, who manages fixed-income hedge funds at the company, said in an interview at Bloomberg’s Toronto office on Oct. 17. “It’s a pretty simple play book. You’re going to see an acceleration in the weakness of the Canadian dollar. It’s going to go a lot faster than people think.”

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