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Loonie Loses Altitude After BOC Signals Dovish Shift

Don Curren October 25, 2017

The loonie suffered a sharp descent Wednesday morning after the Bank of Canada clearly signaled a considerably more cautious approach to raising interest rates in the coming months.

As widely expected, the Bank left its overnight target rate at 1%, but traders were caught off guard by the extent of the dovish shift in tone evident in the Bank’s policy statement.

The Canadian dollar declined by about 1.3% against its US counterpart as the market absorbed the cautious tone of the Bank’s policy statement.

“While less monetary policy stimulus will likely be required over time, Governing Council will be cautious in making future adjustments to the policy rate,” the statement said. “In particular, the Bank will be guided by incoming data to assess the sensitivity of the economy to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation,” it added.

The Bank acknowledged the unexpected strength of the Canadian economy in recent months, indicating it was more broadly based across regions and sectors than expected.

It said growth is expected to moderate to a more sustainable pace in the second half of 2017 and remain close to potential over the next two years, with real GDP expanding at 3.1% in 2017 and 2.1% in. At its last monetary policy report in July, the Bank estimated real GDP growth would be from 2.8% in 2017 to 2% in 2018.

It said it forecasts slower export growth than before, “in part because of a stronger Canadian dollar than assumed in July.”

“Housing and consumption are forecast to slow in light of policy changes affecting housing markets and higher interest rates,” the Bank statement said, referring to recent tweaks to rules governing mortgage lending by regulated financial institutions.

It said its outlook “remains subject to substantial uncertainty about geopolitical developments and fiscal and trade policies, notably the renegotiation of the North American Free Trade Agreement.”

The Bank hiked the overnight target rate by 25 basis points at its July policy date, the first increase since 2010, and by the same amount at its September date. It had cut the rate twice in 2015 as a form of “insurance” against the effects on Canada’s economy of the collapse in oil prices in that period.

The loonie has been closely correlated to interest-rate differentials between Canada and US in recent trading, so the Bank’s positioning will have sustained influence on the currency’s direction. Precisely how that plays out will depend on the actions of the US Federal Reserve – and market expectations about those actions.

Bottom Line: The Bank of Canada shifted to a significantly more cautious tone on interest rates Wednesday, prompting a sharp descent by the Canadian dollar – and perhaps presaging more weakness in the currency as expectations about the Bank’s and the Fed’s monetary policy evolve.

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