Understanding exchange rates

The foreign exchange market determines how much the Canadian dollar is worth. At the Bank of Canada, we very rarely intervene to support its value.

Letting the currency float

If you travel, you know that sometimes you need to exchange more Canadian money to buy foreign currency, and sometimes you need less.

The value of the Canadian dollar rises or falls according to how much people in foreign exchange markets want to buy and sell it—that’s what makes it float.

The Bank of Canada doesn’t try to set the dollar’s exchange rate. We let markets set its value. Because the Bank of Canada lets the Canadian dollar float, we can focus on setting interest rates to maintain inflation at 2 percent in Canada.

Demand for our dollar is affected mainly by demand for Canadian goods and services—the more people want to buy what we sell, the more our Canadian dollar is worth.

The strength of our economy relative to other countries also affects the dollar’s value. Some specific factors that can make our dollar go up or down are:

• our interest rates relative to other countries
• our inflation rate relative to other countries
• demand for our financial assets, like stocks and bonds

Is a stronger or weaker dollar better?

The answer really depends on your role in the economy.

A stronger dollar:

• is good if your business needs a lot of imports, or you are shopping or travelling abroad
• is bad if your business depends on exports, or on visitors coming to Canada

A weaker dollar:

• is good if your business depends on exports, or on visitors coming to Canada
• is bad if your business needs a lot of imports, or if you are shopping or travelling abroad

Floating dollar as a shock absorber

We are part of the global economy—we sell our goods to other countries and they sell theirs to us. We’re affected by what happens around us, but our economy is unique. Our floating currency helps us ride economic ups and downs like a shock absorber on a car.

Take raw materials, for example. Canada is a key producer of oil, minerals and other raw materials. Our economy depends more on resource exports than many other advanced economies do.

• If the price of raw materials falls, our currency tends to drift downward. This makes other Canadian exports, such as cars, aircraft parts and medicines, cheaper for foreign buyers.
• If the price of raw materials rises, our currency tends to float up. This makes exports of such manufactured goods more expensive.

In both cases, these movements in the value of the dollar help investment and jobs shift from sectors that are declining to those that are growing.

Letting the market do its job

The Bank’s intervention policy, which is set out in an agreement with the federal government, is to let the market determine the value of our currency. The Bank would intervene to influence the dollar’s value only in exceptional circumstances, such as:

• if there were signs of an imminent and serious market breakdown—for example, if markets were struggling to determine an exchange rate
• if extreme currency movements seriously threatened the sustainable long-term growth of the Canadian economy

The last time the Bank intervened to influence the Canadian dollar was in September 1998.

How we intervene

If the Bank intervened, we would do so using the Exchange Fund Account. This is a special account that helps control and protect the value of our dollar. It holds international reserves for the federal government.

• If the price of our dollar falls too quickly, the Bank would use other currencies to buy Canadian dollars. This would boost demand for our currency and support its value.
• If the price of our dollar rises too quickly, the Bank would sell Canadian dollars and buy other currencies. This would increase the supply of Canadian dollars in foreign exchange markets and help lower the price of the dollar.

The Bank of Canada has accounts holding billions in foreign currency. Find out why this matters to the Canadian dollar.

We let you know

If we intervene, we announce it on the Bank of Canada website.

The amount of any intervention is also listed in the government’s monthly posting of Canada’s official international reserves.