Canadian interest rates will continue to rise despite the stronger Canadian dollar, says BMO Nesbitt Burns chief economist Sherry Cooper in a written commentary.

Cooper writes, “Remarkable things are happening in Canada”, with the currency at a 12-year high, oil prices at record highs and low inflation. Also, the federal surplus exceeded $9 billion and some of that will go towards lowering tax rates. “The Bank of Canada cut its growth forecast this week, while at the same time raising interest rates. Despite the strength in the Canadian dollar, the trade surplus remains sizable and, even with the hike in overnight rates, bond yields remain low,” she reports.

“Defying historical precedent, we are shifting to a tighter monetary stance and easier fiscal position at the same time that the currency is rising and inflation remains low,” she notes, predicting that this will only further boost the dollar. “The loonie is set to continue to rise next year, challenging exporters to make further adjustments to finally increase productivity growth and reduce unit labour costs,” she says. “Helping has been the offsetting surge in commodity prices. Whether that will continue depends critically on the growth pace of China.”

Cooper says that the yesterday’s Monetary Policy Report from the Bank of Canada confirms that rates are going higher, but that “there is no urgency in hiking interest rates”. Inflation remains very low, but Cooper believes it has likely bottomed.

On the equity side, “Canada has benefited this cycle from its disproportionate wealth in industrial materials and resource companies,” she notes, and the stronger dollar is boosting our relative outperformance to U.S. investors. “The TSX is up 12% in U.S. dollar terms, encouraging the continued inflow of foreign capital to our equity market.”