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Canadian Dollar Slides as Bank of Canada Stands Pat and Leaves Markets Guessing on Next Rate Hike

Canada's economy appears over its recent blip although the BoC remains cautious and strategist opinions on the Loonie are mixed.

The Canadian Dollar weakened Wednesday after the Bank of Canada kept its overnight policy rate on hold and left markets guessing as to when another interest rate rise might be forthcoming.

Canada’s overnight cash rate remains at 1% for December, as expected, although more relevant for currency rates Wednesday was the omission of any hint on when the next rate rise might come.

“While higher interest rates will likely be required over time, Governing Council will continue to be cautious, guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation,” the Bank of Canada says in its statement.

Policymakers noted the recent recovery in Canadian exports, after a summer lull, and a continued pickup in the labour market. Beyond that, the economic backdrop remains broadly in line with the bank’s recent forecasts, which means the next move in interest rates will be as “data dependent” as ever.

“Hawks may be slightly disappointed by the lack of a clear signal of a January hike, but that really isn't their style, and instead, we like others will have to watch upcoming data on October GDP and December employment to fine tune forecasts for when the next hike comes,” says Avery Shenfeld, chief economist at CIBC Capital Markets.

Above: USD/CAD rate shown at hourly intervals.

The USD/CAD rate was quoted 0.50% higher at 1.2760 following the BoC statement, after reversing a 0.20% loss from earlier in the session. The Pound-to-Canadian-Dollar rate was marked 0.27% higher at 1.7075, it too having reversed an earlier 0.51% loss.

Above: Pound-to-Canadian-Dollar rate at hourly intervals.

 

Where Next for the CAD?

The Canadian Dollar could struggle to build on its recent gains over the coming weeks, according Commerzbank strategists, as multiple pressures conspire to keep the Loonie in check and the US Dollar remains bid in anticipation of a succesful tax-reform.

Canada’s Dollar has received a solid bid from the market since last week’s GDP report showed the economy rebounding from a summer contraction, which was complemented by the unemployment rate having posted a surprise fall in November.

“The CAD made good ground against the USD thanks to strong GDP and labour market data at the end of last week, but the BoC’s cautious approach is likely to make further CAD gains difficult,” says Antje Praefcke, a currency strategist at Commerzbank.

“CAD appreciation could create additional downside pressure on inflation. The strong CAD is already putting pressure on the export sector. The BoC will therefore want to avoid seeming more restrictive than the Fed so as to avoid CAD appreciation.”

The Canadian Dollar rose sharply over the summer months as traders responded to the Bank of Canada having raised interest rates twice between July and September, adding 50 basis points to the cash rate, which now sits at 1%.

So swift was the appreciation of the Loonie, the Bank of Canada said by November, that the strength of the currency means it will now take longer for the central bank to hit is inflation target, which took some of the air from the Canadian Dollar’s tyres.

Currency strength is relevant for monetary policy because a stronger currency makes imported goods cheaper to buy and therefore, exerts downward pressure on consumer price inflation.

Central banks are obliged to keep inflation steady by nurturing stronger pressures when inflation is below target and vice versa.

“The NAFTA negotiations also constitute a major risk. So far the talks between the US, Canada and Mexico have not been very constructive and have been extended into the spring 2018,” Praefcke adds.

 

NAFTA and Loonie Bulls

Canada is a party to the North American Free Trade Agreement, which is something that was described by President Donald Trump as “the worst deal in history” for the United States.

For an explainer of what this means for Canadian Dollar buyers and sellers, see our article: Canadian Dollar Could Fall 20% if Washington Walks Away from NAFTA.

The accord is now subject to renegotiation and fears, on the fringes of the foreign exchange community, are that the Washington administration might opt to terminate the deal once into the New Year.

That said, not everybody is pessimistic on the prospect for a succesful renegotiation of NAFTA, or bearish on the Canadian Dollar.

“CAD has been susceptible to the whims of the $ that rallied against nearly all the major currencies at the start of the week, says Mazen Issa, a senior FX strategist at TD Securities.

The US Dollar has strengthened notably over the last week as traders bet that the Trump administration’s push to cut taxes will be succesful, helping to offset some of the rediscovered strength in the Loonie.

“Still, with oil prices starting to build a base around the old highs and the BoC likely to sound more upbeat we continue to look for renewed downside momentum in USDCAD near-term,” adds Issa.

WTI crude oil has risen by close to 25% over the last three months, which is notable for Canada as it is a large oil producing country. So far, the price increase has failed to boost the Loonie but that hasn’t stopped strategists from betting on an eventual lift in the currency.

“Also keep in mind that the market is priced to perfection on a Fed hike this month while the OIS is pricing the BoC at a coin toss next month,” warns Issa. “We suspect there is more upside in the latter and note that Canadian data momentum is starting to improve.”

TD Securities have been recommending to clients that they bet on a fall in the USD/CAD rate, which could take the pair down below 1.2400. They entered the trade around the 1.2770 level, placing a stop loss at 1.2960 and are targeting a move lower down to the 1.2380 threshold.

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