Canadian Dollar Downside Ahead as Bank of Canada Faces Up to Reality, Says NBC

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A major Canadian bank predicts more noticeable Canadian Dollar weakness over the coming months as the Bank of Canada confronts the reality that interest rates are too restrictive.

Recent Canadian Dollar strength has been described as "tepid" by analysts at National Bank of Canada (NBC), particularly when its performance is screened against fellow 'commodity currencies', such as the Aussie and Kiwi Dollars.

Analyst Stéfane Marion describes the Canadian Dollar as "the weakest of the strong" and says, "this weak performance versus other commodity currencies can be attributed to underwhelming economic data."

Marion breaks down recent Canadian economic data and points to the soft details underlying the Q4 GDP growth figures, which included confirmation that domestic demand fell for the first time in a year.

Marion says the soft fundamentals of the Canadian economy have the Bank of Canada to thank, where the 5.0% policy rate is squeezing the life out of the economy.

"The negative impact of restrictive monetary policy becomes clearer when we look at private domestic demand, which contracted for the second quarter in a row and has now fallen four times in six quarters," says Marion.

"The restrictive monetary policy in Canada can no longer be justified," he adds.

NBC meanwhile reckons Canada's most recent labour market figures paint a too-optimistic figure, as the headline 41K growth in February was fluffed by public sector openings. Indeed, private-sector employment has actually been flat since June 2023.

According to the analysis, all signs point to the need for the Bank of Canada to cut interest rates. On a year-over-year basis, inflation has already returned to the Bank of Canada's 1-3% target range, rising 2.9% compared with the economists' consensus of 3.3%.

"This downside surprise to inflation, relative to expectations, was the most pronounced since September 2018," says Marion.

This bodes for a realisation at the Bank of Canada that rates must come down substantively, which will have connotations for Canadian Dollar exchange rates.

"The restrictive monetary policy in Canada can no longer be justified. As we continue to believe that rate cuts will be more aggressive on this side of the border, we still see USD/CAD moving above 1.40 in H2 2024," says Marion.