CAD – Canadian Dollar

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On the further improvement of the outlook for the Canadian economy, the BoC has brought forward slightly the date of the expected closing of the output gap. However, to prevent an unwelcome appreciation of the exchange rate, it reasserted and stressed that there is still material excess capacity in the system.

The Canadian dollar opened 2017 stable, staying at the beginning of the year roughly inside the same range outlined in the last quarter of 2016, between USD/CAD 1.30 and 1.35. In the near term, this should be confirmed as the prevailing range. At its meeting of 12 April, the Bank of Canada – which left rates unchanged once again at 0.50% – noted an overall improvement of the macro scenario, although it made a point of stressing several elements that advise keeping a cautious and accommodative monetary policy stance in place.

At the global level, growth is strengthening – and proving more widespread than the BoC expected in January – although the scenario is still marred by considerable uncertainties, tied especially to the Trump administration’s future economic and trade policies, but not only (given the recent developments on the Middle Eastern and North Korean fronts). For what concerns the United States in particular, the BoC noted that the factors which negatively affected the economy at the beginning of the year were only of a temporary nature, and growth remains solid. The US economy is now virtually at full employment levels, unlike other advanced economies, including the Canadian, where (the BoC stressed once again) there is still material excess capacity.

With reference to the domestic economy as well, the central bank observes that growth has proven stronger than it had forecast in January, while at the same time noting that export growth has been irregular – due to persistent competitiveness issues that would worsen further if Trump were to effectively implement protectionist measures – and that investments, while recovering, remain well below the levels that could be expected in the present phase of the cycle. Therefore, although recent progress is undoubtedly encouraging, the BoC believes it is too soon to conclude that the economy is back “on a sustainable growth path”.

The Monetary Policy Report brought a significant upward revision (compared to January) of this year’s growth forecast, from 2.1% to 2.6%, as opposed to a downward revision of 2018 growth, from 2.1% to 1.9%, forecasting a further (albeit marginal) deceleration to 1.8% in 2019. At the same time, due to the persistent weakness of investments, ha revised down its projection of potential growth, which, together with the upward revision of growth in 2017, implies that the output gap may close a little earlier than previously estimated, i.e. in the first half of 2018 instead of mid-2018. As a result, the inflation forecast was also revised up, both for this year, from 1.8% to 1.9%, and for 2018, from 1.9% to 2.0%. Inflation at the end of 2019 is forecast at 2.1%.

The revision of inflation forecasts was marginal in size, but meaningful as a signal, as the BoC now expects a return to target (2.0%) a year sooner, in 2018, and a stabilisation slightly above target the following year. The early achievement of the inflation goal, and the early closing of the output gap, may be interpreted as a signal that the BoC intends to preannounce the start of a rate hike cycle next year: something the BoC wants to avoid at all costs, to prevent both a premature rise in market rates and yields, and an unwelcome appreciation of the exchange rate. This is why the central bank, at its April meeting as well, reasserted that – unlike the US economy – the Canadian economy still presents material excess capacity.