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Loonie Tumbles as BOC Turns Dovish

Don Curren December 5, 2018

The Canadian dollar took a tumble Wednesday morning, dropping to its lowest level since May 2017, after the Bank of Canada acknowledged the impact of lower oil prices on the country’s economy and positioned itself more dovishly on interest rates while retaining its overall tightening bias.

The loonie dropped by roughly 1% against its US counterpart after the Bank released its last policy statement of the year Wednesday.

As expected, Canada’s central bank left its overnight target rate at 1.75%

The Bank said the Canadian economy grew in line with its projection in Q3, although data suggest less momentum going into the fourth quarter. “Business investment fell in the third quarter, in large part due to heightened trade uncertainty during the summer,” it said.

The statement reaffirmed the Bank’s earlier position that that the policy interest rate will need to rise into a neutral range, estimated to be between 2.5% and 3.2%, to achieve its 2% inflation target.

But the Bank said the appropriate pace of rate increases will depend on a number of factors. “These include the effect of higher interest rates on consumption and housing, and global trade policy developments,” it said.

“The persistence of the oil price shock, the evolution of business investment, and the Bank’s assessment of the economy’s capacity will also factor importantly into our decisions about the future stance of monetary policy,” said.

The statement acknowledged that oil prices have fallen sharply since the October Monetary Policy Report (MPR), reflecting a combination of geopolitical developments, uncertainty about global growth prospects, and expansion of U.S. shale oil production.
“Benchmarks for western Canadian oil – both heavy and, more recently, light – have been pulled down even further by transportation constraints and a buildup of inventories. In light of these developments and associated cutbacks in production, activity in Canada’s energy sector will likely be materially weaker than expected,” the Bank said.

Importantly, the statement said that downward historical revisions by Statistics Canada to GDP data, “together with recent macroeconomic developments, indicate there may be additional room for non-inflationary growth.”

Economists were essentially unanimous in expecting the Bank to hold its overnight target rate at 1.75%, but were uncertain what tone its policy statement would strike in response to the sharp decline in crude oil prices and the province of Alberta’s controversial decision to impose a production cut.

The central bank has raised borrowing costs five times since July 2017, when it shifted abruptly to a tightened bias after maintaining a neutral stance for more than two years after cutting twice in 2015.

A recent survey by Bloomberg indicated the consensus expectation was for the Bank to raise the overnight target rate to 2.5% by the end of 2019.

Bottom Line: The Bank of Canada acknowledged some of the challenges facing the Canadian economy and said there may be more room for non-inflationary growth than earlier believed. The market correctly interpreted the statement as adding considerable dovish nuance to the Bank’s tightening stance, and the Canadian dollar plummeted as a result, and could be vulnerable to further weakness in the coming sessions.

Don Curren
Content Editor and Strategist
dcurren@cambridgefx.com
@dbcurren

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