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CURRENCY ANALYSIS

CAD Canadian Dollar:

BoC Rates Still Unchanged, But the News is Inflation

CAD, Canadian Dollar, BoC Rates, Still Unchanged, News, Inflation, fx trader, forex

14 Sep 2016

As unanimously expected, the Bank of Canada left rates unchanged at 0.50% at its meeting of 7 September, but the Canadian dollar weakened slightly, from USD/CAD 1.28 to 1.29.

The BoC made an assessment of the economic scenario that was weaker than projected in the July Monetary Policy Report, at both the international and domestic levels, and it reported that in 1H 2016 the global economy grew at a slower pace than forecast. In particular, the US economy proved weaker than expected in 2Q.

Foe what concerns the domestic economy, the BoC reasserted that the sharp contraction incurred in 2Q (-1.6% q/q ann.) was explained by the May wildfires in Alberta, but made worse by the disappointing performance of exports. The deterioration of the export trend was the main reason that prompted the central bank to consider a downward revision of growth estimates. A crucial event in this sense will be the next BoC meeting, on 19 October, as on that occasion the new MPR will be released, containing updated growth and inflation forecasts.

In any case, the BoC continues to expect a rebound starting already in 3Q, and forecasts above-potential growth in 4Q as well, thanks to the favourable projected performance of oil quotations and to the positive effects of the expansive fiscal measures introduced with the March budget.

However, the main development brought by this latest meeting concerned inflation. Up to last month, risks to the inflation scenario were considered to be balanced, whereas now the BoC believes they are skewed to the downside. For what concerns overall inflation, the BoC observed that it is lower than the 2% goal due to the temporary effect of lower energy prices, whereas core inflation remains at around 2%, as the past depreciation of the exchange rate is offsetting the negative effects of excess production capacity. The October meeting will be important from this point of view as well, to verify whether the BoC will further postpone the date of the expected closing of the output gap, which had already been pushed back to around the end of 2017 in the July MPR.

In any case, while downside risks to inflation are increasing, financial vulnerabilities persist tied to imbalances in the trend of private debt in relation to real housing market prices, which would make it risky to maintain markedly expansive monetary conditions for a very long period of time.

In the near term, therefore, we confirm our expectations for a modest weakening of the Canadian dollar, to inside the USD/CAD 1.30-1.35 range, in function of a possible downside revision of growth and/or inflation forecasts by the BoC.

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