Exchange Rate

The Canadian dollar is a freely floating currency which has experienced some volatility over the past year. After trading around 65 US cents in the last quarter of 1998, the Canadian dollar strengthened with the increase in world commodity prices, peaking near 69.7 US cents in late January 2000 before losing ground to trade at about 67 US cents in late May 2000. The average rate for 1999 was 67.3 US cents.

Since May 1999, Canadian market interest rates have risen along with those in the United States, with the average Canadian short-term interest rate stabilizing at 4.94 percent (90 day commercial paper) for 1999. More recently, though, on May 16, 2000 the U.S. Federal Reserve raised the target for the Federal Funds Rate from 6.0 percent to 6.5 percent, its sixth round of monetary tightening since mid-June 1999. These moves were aimed at staving off inflationary pressures that might arise from a tight U.S. labour market, continued strong U.S. domestic demand and firming foreign economies. Consequently the Bank of Canada matched these recent interest rate increases by the U.S. Federal Reserve.

Fiscal Policy

Canadian fiscal policy is reflected in the annual federal budget. In the February 2000 Budget, the central themes included the maintenance of sound financial management, lowering of taxes, investments, skills and knowledge provision, and building of an innovative economy. The government is committed to having either balanced budgets or surpluses in the years 1999 ¨C 2000, 2000 ¨C 01 and 2001 ¨C 02. This would be the first time in the last fifty years that the budget has been balanced or in surplus for at least five consecutive years. By accounting standards used in most other countries, the Government of Canada will post a financial surplus for the fourth consecutive year in 1999 ¨C 2000, the only Group of Seven (G-7) country to do so.

The further reduction of the debt-to-GDP ratio, estimated to be about 61 percent in 1999 ¨C 2000, remains a key objective of the government¡¯s fiscal policy. Continued application of unused contingency reserve funds against the public debt will ensure that the debt-to-GDP ratio continues to decline to about 55 percent by 2001 ¨C 02 and to under 50 percent by 2004 ¨C 05.

The fiscal position of provincial-territorial governments is expected to improve for the seventh consecutive year in 1999 ¨C 2000, resulting in their combined deficit falling to its lowest level in more than 20 years. Based on current plans and the commitment of all provinces and territories to having balanced budgets in the medium-term, the total provincial-territorial deficit should continue to decline.

Monetary Policy

Since 1991, the Federal Government and Bank of Canada have jointly announced an official target range for the inflation rate. This target range has been gradually lowered since it was first announced and currently stands at 1 percent to 3 percent. In February 1998, the commitment to maintain inflation within the 1 percent to 3 percent target range was renewed until December 2001. The appropriate long-run target for monetary policy will be determined by the end of 2001.

In 1998, plunging commodity prices and the Asian crisis, compounded by the possibility of a Russian default and related capital flows, caused a substantial decline ¨C a record low ¨C in the Canadian dollar. As a consequence, the Bank of Canada increased the Bank Rate a full percentage point (to 6.0 percent) on 27 August 1998. However, since the underlying strength of the Canadian economy resulted in its quick recovery from these shocks, the Bank of Canada subsequently made a series of interest rate cuts over the September 1998 to August 1999 period, more than reversing the 100 basis points increase of August 1998.

On 17 May 2000, the Bank of Canada raised its target for the overnight rate by one-half of one percentage point to 53/4 percent (following earlier increases in November 1999, and February and March 2000). The Canadian bank rate is now 6 percent. In its latest Monetary Policy Report, the Bank of Canada took note of the strength of demand in Canada from both international and domestic sources, some early signs of pressures on capacity limits, and the need to lean against these trends in order to preserve the low and stable inflation environment that has been benefiting the Canadian economy.

An important source of this strong growth in demand has been the U.S. economy. The May 16, 2000 action by the U.S. Federal Reserve to raise its target level for the federal funds rate by 50 basis points underscores the strength of the U.S. economy and the continued risk of demand and inflation pressures spilling over from the United States into Canada.

The move by the Bank of Canada in May 2000 therefore reflects the judgment that a tightening in monetary conditions in Canada is warranted, given that the underlying momentum of demand growth and the high levels of activity risk putting excessive pressure on the economy¡¯s capacity limits, and thus on inflation. The Bank is of the view that the commitment to a low and stable inflation environment enables policy to best contribute to a sustained economic expansion in Canada, thereby leading to the likelihood of lower unemployment and improved productivity.

Medium-term Outlook

On the whole, Canada¡¯s near-term economic prospects remain solid. Anticipating a slowdown in the U.S. economy and somewhat higher interest rates, private Canadian forecasters are predicting real GDP growth to be in the 4 percent range in 2000 and to remain healthy in 2001. The Organization for Economic Cooperation and Development and International Monetary Fund project that Canada will have the second fastest economic growth among the Group of Seven major industrial countries in 2000. This will lead to a lot of job creation.

A strong world economy and the resulting support for commodity prices ¨C combined with firm domestic demand, continued low and stable inflation and sound public finances ¨C should, help offset much of any negative impact from a U.S. slowdown. Inflation pressures are widely expected to remain contained over the next two years, reflecting the success of the inflation control targets and indications that Canada¡¯s capacity to sustain non-inflationary growth has increased as a result of structural reforms, the restoration of sound public finances and technological developments.

CANADA: OVERALL ECONOMIC PERFORMANCE