The Canadian dollar (CAD-USD-I) is overvalued and needs at least to soften somewhat, but its strength isn't enough to kill the recovery, economists say. The outlook for Canada's economy and its fiscal standing, compared to its peers, have been drawing money into the country, notably into bonds. At the same time, the U.S. dollar (USD/JPY-I83.47-0.06-0.07%) has depreciated. What we're left with is a Canadian dollar that has appreciated and is expected to continue rising - according to some economists, to hold above parity next year. That can spell trouble for exporters and manufacturers as a stronger currency pushes up the costs of their goods to foreigners. But, asks assistant chief economist Yanick Desnoyers of National Bank Financial, is it an economy killer? "The fact is, if there is one cyclical currency that can appreciate, it is the Canadian dollar," Mr. Desnoyers said in a research note, pointing out that Canada's real effective exchange rate, which is weighted by the value of exports to Canadian trading partners but also takes into account inflation differentials, sits at just about where it was in 2000. "This also stands out when compared to other major cyclical currencies as Canada remains competitive," Mr. Desnoyers said. "Consequently, there is room for the loonie to rise without killing the economy." In a separate report on Canada's trade and current account deficits - the former is near a record - deputy chief economist Douglas Porter of BMO Nesbitt Burns noted that the latter is "at least a warning signal" that the loonie may be overvalued. The loonie, he said, has far outpaced the run-up in commodities, and based on such prices would be "more appropriately valued" at a range in the low- to mid-90-cent level. His report projects, as have others, that exports will remain a drag on economic growth next year. While net foreign liabilities are negligible at this point, it would be a concern if Canada ran large current account deficits for several years. Current account balances are the broadest measures of trade. "Canada suddenly finds its broad trade deficit in the company of countries that have typically been cited as extravagant over-spenders/under-savers," Mr. Porter said. While this could be just a "passing phase," one of four developments needs to occur to make certain it doesn't become chronic: The U.S. will have to start spending again. The loonie will have to soften Canadians and Canadian governments will have to spend less. Prices for commodities key to Canada's economy will have to boom. Ed Devlin of PIMCO also noted in an article on the company's website that "we are long-term bullish" on the loonie. He, too, believes that global developments add to the attractiveness of the currency, but notes that "a distortedly high Canadian dollar is a problem for Canada as it will hurt our ability to export and tighten financial conditions on all consumers and businesses."

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