Loonie Still Appreciating In January 2018, the Bank of Canada raised its interest rate to 1.25 percent, which strengthened the Canadian dollar, the highest exchange rate in four months of CAD1.225 per USD at the start of February. Two further hikes are expected this year. However, if the United States withdraws from NAFTA, the Canadian dollar is likely to depreciate as the United States is a major trading partner for Canada.

Source: Reuters, February 8, 2018

a. How does the higher interest rate influence the Canadian dollar exchange rate, other things remaining the same?

b. How do the expected future hikes in the interest rate influence the Canadian dollar exchange rate, other things remaining the same?

c. Explain what happens to the Canadian dollar if the United States withdraws from NAFTA.