OTTAWA - The Canadian dollar is undervalued and will soon soar above the U.S. currency again if world oil prices hold up as expected, predict two senior economists, raising the spectre of more troubles ahead n the export-dependent manufacturing economy.

With oil forecast to end the year near US$150 a barrel, the loonie should rise from the current 98-cent US level to about $1.03, say economists Dale Orr of the forecasting firm Global Insight Canada and Avery Shenfeld of CIBC.

The forecast of a rising loonie will be welcomed by some in Canada, but send shivers down the spines of others in factory and mill towns across the country, whose livelihoods have been threatened by the dollar's appreciation in the last six years.

But with demand for oil expected to outstrip supply for some time, it would be difficult for the Canadian dollar - known as a petro-currency because of Canada's large reserves that are second only to Saudi Arabia - to resist an upward revision, the economists say.

Some economists have disputed the inevitability of a rising loonie, saying the dollar could fall from current levels for a variety of economic reasons.

But Orr said the loonie would already be higher had markets not considered the recent rise in oil prices a temporary spike.

"So much for the temporary oil spike phenomenon," he said. "It's time for the dollar to reflect the fact that oil above $100 a barrel is with us for some time."

The link between oil and the loonie has been established since 2003, when oil began its ascent from US$34 a barrel to US$95 in November last year. During that time, the loonie climbed from about 66 cents US to just above $1.00 US.

But since November, the two parted company and the dollar has actually slid below parity at the same time that oil soared to the US$140 level.

"There are many explanations which are possible - political and or economic, as is always the case with exchange rates," writes Orr.

"However, the most likely reason why the Canadian dollar did not appreciate further above par as the price of oil continued to rise... is that the rise in oil prices was considered to be temporary."

Shenfeld also projects the dollar will recoup lost ground in 2009, saying other reasons for the lag include the fact that the U.S. dollar has strengthened as investors expect U.S. interest rates will head higher.

"Also the market has some concern, given what's happening in Canada's manufacturing sector, the economy can't live with a much stronger exchange rate," adds Shenfeld.

The rise of the Canadian dollar, particularly in the past year, has altered the economic landscape of Canada for the good and bad.

The strong currency has helped Canada largely avoid the price inflation currently troubling the U.S. and Europe, making everything from food, gasoline and cars comparably cheaper to Canadian consumers. As well, the high dollar has been a boon to Canadian snowbirds vacationing in the U.S., or cross-border shopping and it has cut the costs of anything imported into Canada from the United States - from Florida oranges and California vegetables to machinery, computers and books.

But the loonie's heady heights has also increased the price of products such as cars, lumber and auto parts that Canada exports - making them less competitive - and played a critical role in choking off economic growth.

On the ground, factories in Ontario and Quebec, as well as the forest industry, have been decimated by a combination of the strong dollar and low demand in the U.S., leading to numerous plant and mill closures and resulting in the loss of about 130,000 in 2007.

As well, sectors such as the tourism industry have seen U.S. visitors virtually disappear, discouraged from travelling north both by their devalued greenbacks and the high cost of gasoline.

Shenfeld cautions that concerns a pumped-up dollar will further batter Canada's manufacturers could continue to hold back currency markets from allowing the loonie to rise much beyond parity, despite what oil prices do.

The loonie was largely unchanged Tuesday, down 0.02 of a cent to 98.13 cents U.S., while crude fell over US$5 a barrel to just under US$136.

Economists agree that forecasting currency movements is far from an exact science, given what Orr calls the "thousand and one" variables that impact exchange rates. And depending on the assumptions, economists can disagree not only about the relative future value of a currency, but also the direction it is headed.

For instance, last week the Royal Bank forecast that the loonie, rather than rising, would drift lower and close out the year at the 94 cent US level, then fall further to around US$89 cents US by the end of 2009.

The analysis, says chief economist Craig Wright, is based on several assumptions, some of which differ from those of Orr and Shenfeld. These include more moderate oil prices as global growth slows, a stronger U.S. economy firming up the U.S. greenback, a narrowing Canadian trade surplus, and a slowing level of foreign takeovers of Canadian corporations, which helped boost the loonie the past two years.

The key, given Canada's abundance of natural resources, is commodity prices, particularly oil, agrees Wright. But there is no unanimity on that question, he adds.

"Consensus Economics out of the U.K. surveys about 65 forecasters every month and their mean forecast for oil one year forward is US$110 a barrel, the high is US$140 and the low is US$68," he notes. "So there's a very wide range of views for oil prices."

Both Orr and Shenfeld assume oil will remain much in demand for the rest of the year, ending 2008 at $150 a barrel.

Orr said he looked at the issue of whether speculation had driven the Canadian dollar beyond fundamentals last year and concluded speculation only impacted the run-up when the loonie briefly touched $1.10 last November. At slightly above par, however, he said the dollar basically just followed oil prices.

Still, he does not believe the dollar will fully follow oil prices, which would mean a dollar well above parity.

"At a $1.03, I'll still be saying the Canadian dollar is undervalued," he said.

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