Canadian Dollar Dips after GDP Contraction as Economists Eye July for Next BoC Move

- Canadian economy contracts in January for second time in 12 months.

- Contraction driven by fall in oil production and real estate activity.

- Economists now see the Bank of Canada on hold until July. 

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The Canadian Dollar pared back its earlier gains during noon trading in London Thursday after Statistics Canada data showed the economy contracting during January, delivering a dent to those few who may still have hoped the Bank of Canada will raise interest rates at its April meeting.

Canadian GDP fell by -0.1% during January when markets had been looking for a 0.1% rise. This is below the already-reduced 0.1% rate of growth seen back in December and substantially beneath the 0.6% growth recorded for January last year. It also marks the second monthly contraction for the economy since the BoC began to raise interest rates last July.

Statistics Canada attributes the fall to a decline in non-conventional oil output, which posted its largest decline since May 2016, and decreased transaction activity in the real estate market. It also says Canada's services sector produced its weakest monthly growth rate for more than a year this January. 

"The news wasn’t all bad, though," says Nathan Janzen, a senior economist at Royal Bank of Canada. "The big drop in home resales in January alone subtracted about 0.1 percentage points from headline GDP growth. Home resales have remained soft, but that decline probably won’t be repeated to the same extent."

Janzen also flags that the January drop in oil sands production is believed to have been the result of maintenance activity and that, after removing oil and real estate from the figures, Canada's economy ticked along nicely at the start of the New Year.  

The USD/CAD rate was quoted 0.6% lower at 1.2909 following the release after having dialled back an earlier 0.19% loss, while the Pound-to-Canadian-Dollar rate was 0.23% lower at 1.8146.

"Does the Canadian economy need rate hikes to slow it down, or maybe its already slowing enough on its own? That's what markets, and the Bank of Canada will be asking in light of today's January GDP numbers," says Avery Shenfeld, chief economist at CIBC Capital Markets. "We expect a bounceback in Feb/March GDP, but we're going to revise down our Q1 GDP forecast to sub-2%, adding weight to our view that the Bank of Canada is on hold until July."

Canada's economy saw a strong run of growth during the first half of last year with the expansion gaining momentum to reach an annualised pace of 4.5% in the second quarter, which prompted the Bank of Canada to raise interest rates three times before the end of January 2018. Amid this tightening of monetary policy, momentum has ebbed from the economy and expectations of future rate rises have waned, leaving the Canadian Dollar at a loss.

The Bank of Canada last raised its interest in January, by 25 basis points to 1.25%. At the time traders in interest rate derivatives markets were happy betting the central bank would manage a total of three interest rate rises in 2018 as a whole and assigned a 75% probability to another rate hike in April. Since then, those same markets have become less convinced and are now pricing just one more rate rise for 2018, while the implied probability of a move next month has fallen to just 20%.

"The loonie comes into the monthly GDP print with little directional bias. It failed to hold the inflation-inspired rally but a mix of lopsided positioning and wobbly equity markets have offered conflicting signals. In turn, we are mostly neutral on the week," says Fred Demers, chief Canada macro strategist at TD Securities. "The key level to watch is the fib level from the January lows around 1.2920. A break there fuels a move towards 1.30 and a re-test of the highs near 1.3132."

Canada’s unit is down by 2.6% against the US Dollar for the year to date, which is a steeper fall than those experienced by the beleaguered Australian Dollar and Swedish Krona, both of those being the only other G10 currencies to cede ground to their US rival this year. It has fallen by more than 7% against Pound Sterling.

Much of this move has been the result of changes in interest rate expectations, although some of it is also due to uncertainty over the future of the North American Free Trade Agreement. Indeed, the two are closely intertwined as the BoC has frequently cited uncertainties over trade as key risks to its outlook for the Canadian economy.

This is in the process of being renegotiated at the behest of US President Donald Trump who once described it as “the worst deal in history” while out on the campaign trail. The White House, citing a number of concerns about the deal, has threatened to withdraw the US from NAFTA if more palatable terms cannot be agreed. 

Some analysts have previously suggested the Canadian Dollar could fall as much as 20% if the US walks away given the likely consequences for the Canadian economy and they might be right as the 2.6% 2018 rise in the USD/CAD rate comes against a -5.7% fall in the broader US Dollar index and the US hasn’t actually withdrawn from the pact yet.

Negotiators will have one last round of meetings in April to seal a deal before talks are placed on hold pending Mexico's Presidential election and the US midterms in November. If a deal cannot be reached then the current cloud of uncertainty will hang over the Canadian economy, as well as its currency, until year end.

However, in the event a deal is struck, a growing number of strategists have recently cited this as something that could lift the Loonie by some 7% against the US Dollar. Presumably, it would also help to unwind much of the Canadian currency's loss relative to Pound Sterling.

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