FX comment – Canadian dollar gains after a more optimistic Bank of Canada

by: Roy Teo

  • Rate cut expectations reduced after a more optimistic Bank of Canada
  • Gains in the Canadian dollar unlikely to be sustainable

 

Rate cut expectations reduced after a more optimistic Bank of Canada

As expected the Bank of Canada (BoC) left its overnight rate at 0.75% overnight. However we sense that the central bank is more optimistic and confident on the economy going forward. The BoC stated that though the impact of the oil price shock is faster than initially expected, it is not larger. Economic growth is projected to recover in the second quarter and to grow above trend rate thereafter. The interest rate cut in January and lower Canadian dollar (CAD) are beginning to support the non-energy export sectors. Overall the BoC seems optimistic on the economic outlook and that further rate cuts are less likely. GDP growth is projected to rise from 1.9% in 2015 to 2.5% in 2016. Indeed financial markets scaled back the magnitude of rate cuts by the end of this year by 10bp after the announcement.

Gains in the Canadian dollar unlikely to be sustainable

A more optimistic BoC outlook and weak US industrial production print overnight were strong catalysts for the CAD to break out of its 10 weeks trading range of 1.2350 and 1.2830. We think that the technical break below 1.2350 is significant and could result in further CAD gains towards 1.18 against the US dollar. In our view, we continue to favour fading further gains in the CAD as a recovery in the exchange rate will result in a more dovish central bank. The BoC highlighted that the decline in the CAD has boosted total inflation by 0.6 to 0.7pp. Furthermore a stronger exchange rate will weigh on the exports sector. We expect the US economy and tighter monetary policy to lead the Canadian economy and this should be positive for a higher USD/CAD. Nevertheless the risk has increased that prices may end the year lower than our year end target of 1.30.