FX comment – Canadian dollar recovers as Bank of Canada shifts from dovish to neutral tone

by: Roy Teo

  • Bank of Canada kept monetary policy unchanged overnight
  • Canadian dollar recovers 1% to almost 1.24

BoC keeps monetary policy unchanged with neutral tone

As expected the Bank of Canada (BoC) left its overnight lending rate at 0.75%. There are several reasons to adopt a wait and see approach. First, economic growth in the last quarter of 2014 was consistent with expectations. Second, crude oil prices are close to the central bank’s assumptions. Third, the anticipated rotation into stronger growth in non-energy exports and investment is well underway. Fourth, core inflation remains close to 2% and continues to be temporarily boosted by weaker exchange rate. Last but not least, financial conditions in Canada have eased materially since the last rate cut in January. These conditions will mitigate the negative effects of the oil price shock which are expected to appear in the first half of this year. On balance the BoC has judged that the current degree of monetary policy stimulus as appropriate.

Canadian dollar recovers to almost 1.24

Though financial markets have widely expected the central bank to keep monetary policy unchanged overnight, the relatively neutral tone with little emphasis on the risks to the economy was positive for the Canadian dollar (CAD). Indeed financial markets have priced out rate cuts this year (similar to our view), compared to more than 50% probability of 25bp easing in the last quarter of 2015. Nevertheless, we expect the recent recovery in the CAD to fade towards 1.2350 before easing to 1.27 by the end of this year. This is supported by our view that both economic growth and monetary policy tightening bias in Canada will lag the US in the coming two years.