The Canadian dollar soared yesterday. The Bank of Canada (BoC) dropped the reference to raising interest rates "gradually" in favour of just announcing that policy rates will rise to the neutral rate. That move was considered a hawkish development and traders scramble to buy Canadian dollars; so many, in fact that the currency gained over 1.3 cents to the U.S. dollar.
The "neutral rate" of interest for central banks is defined as the level where real Gross Domestic Product is growing at the trend rate while inflation is stable. (Financial Times Lexicon definition)
Yesterday’s BoC rate hike lifted the overnight rate to 1.75% from 1.5% which is well below its estimate of the Canadian neutral rate which is 2.5% to 3.5%. When the Governing council removed "gradual" from the policy statement, it implied that it might be in more of a hurry to achieve the "neutral rate." Some analysts revised their Canadian interest rate forecasts and are looking for another rate increase at the December 6 meeting.
Those analysts ignored Governor Stephen Poloz and Deputy Governor Carolyn Wilkins' explanation for deleting "gradual" from the statement. They said it was to remove the perception that the BoC followed a predetermined rate path. Mostly, they were unhappy with forecasts that expected a rate increase every quarter. They repeated that rate moves were data-dependent.
Nevertheless, the BoC policy statement and MPR were upbeat. The Bank expects an increase in business confidence and investment as a result of the United States Mexico Canada Agreement (USMCA) which removed a cloud of uncertainty for companies and investors. The BoC noted that the domestic economy was operating at or close to its potential with a more balanced composition of growth. Economic growth continued to be supported by robust household spending and employment income growth.
Governor Poloz acknowledged during the press conference that the risks to the outlook suggested rates could rise or fall. Of notable concern was the impact to global economic growth from the ongoing U.S./China trade dispute. This issue poses two-side risks. An escalation of the trade war could derail global economic growth which would have a negative impact on Canadian exports and investment which could trigger rate cuts. On the other hand, an end to the dispute and tariffs could spark a sharp rise in global and domestic economic activity necessitating higher rates.
U.K. and European political issues are other factors causing FX market turmoil. There is not just a rising risk of a "no-deal" Brexit, but U.K. Prime Minister Theresa May could lose her job as well. Many Conservative Party Members of Parliament are unhappy with her handling of the Brexit file and want her gone.
Italy and the European Union are at an impasse over Italy’s plans for a 22.4% of GDP budget deficit. The issue is that, if the European Union lets Italy flout the rules, it could cause a ripple effect in other E.U. nations.
This morning’s U.S. data includes Durable Goods Orders, but Wall Street will drive FX price movements.
Rahim Madhavji is the President of KnightsbridgeFX.com, a Canadian currency exchange that provides better rates than the banks to Canadians
