FX comment – Canadian dollar recovers after Bank of Canada douse market speculation that rate cut is imminent

by: Roy Teo

  • Bank of Canada douse market speculation that rate cuts are imminent
  • Overnight lending rate to remain unchanged at 0.75% in 2015
  • CAD recovery to fade around 1.2350 before easing to 1.27 later this year

Bank of Canada douse market speculation that rate cuts are imminent

The Canadian dollar (CAD) strengthened by more than 1% early this morning to below 1.25 after the Bank of Canada (BoC) douse market speculation that another 25bp rate cut is imminent. Indeed prior to BoC governor Poloz speech, the market has fully priced in a 25bp rate cut in next week’s monetary policy meeting on 4 March. Mr Poloz stated that the decision to lower the policy rate by 25bp last month was to insure against the uncertain risks due to lower oil prices and would allow the central bank some flexibility to see how the economy respond. Furthermore he also noted that oil prices have to a certain extent stabilized at a level they had set in their monetary policy announcement in January. On the exchange rate, he also acknowledged that the CAD has reacted to economic fundamentals and that the direction in oil prices will have a material influence on the CAD going forward.

BoC to keep monetary policy unchanged this year

Recent economic data releases have been mixed. On the bright side, the Canadian dollar has declined by about 4% while WTI oil has recovered by more than 5% since the BoC unexpectedly cut rates by 25bp on 21 January. This should give some comfort to oil producers and benefit the non-energy export sectors. Core inflation in December has edged higher by 10bp to 2.2% with January business activity price sub-component imply that core inflation is expected to remain firm in the near term. House price growth has also slowly gained pace in the second half of 2014. This will give the central bank less flexibility to further ease monetary policy as soon as next month. In addition, we suspect the weaker than expected retail sales in December was partly due to seasonal factors. On the other hand, economic growth in November contracted by 0.2% mom and we think that any recovery is expected to remain subdued in the near term. The better than expected employment gains in January is also unlikely to be sustainable in our view. On balance, we maintain our view that the BoC is likely to keep the overnight lending rate at 0.75% this year as we expect Brent crude oil to recover to USD 65 later this year. Furthermore we are more optimistic on the US economy (3.8% GDP in 2015) than the central bank’s forecast of 3.2%.

CAD to ease lower towards 1.27 by end 2015

Financial markets have pushed out a 25bp rate cut expectation from March to the last quarter of this year against our view of no change. We expect the recovery in the CAD to face stiff resistance around 1.2350 in the short term. Looking ahead, as the market is underestimating the pace of rate hikes in the US more in our view, we continue to expect the CAD to underperform the US dollar towards 1.27 by the end of this year.