On October 30, the Bank of Canada announced that it was keeping its key overnight lending rate at 1.75%. Keeping interest rates pat generally means the central bank is optimistic about the economy, which is good for the Canadian dollar. Not this time. The Bank of Canada forecasted a weaker domestic outlook over the next two years. This opens the door for potential rate cuts in the coming months, which is bad for the Canadian dollar.
What Is the Bank of Canada’s Outlook on the Canadian Economy?
The Bank of Canada maintained its key lending rate at 1.75%. This was the eighth straight meeting in which the central bank has done so. With this move, Canada’s policy rate is now the highest in the G7 and the industrialized world.
It called the level “appropriate” even though it cut its growth forecast for the next two years.
Despite holding its lending rate unchanged, the bank was more dovish about the Canadian economy.
This does not necessarily mean that the Bank of Canada will announce a cut at its next meeting in early December, but it does leave the door open for a December cut. Though how affective that will be is open for debate, as it no longer suggested that rate moves stimulate economic growth.
The Bank of Canada’s move is in sharp contrast to what is going on in the U.S. On the same day, the Federal Reserve cut its benchmark interest rate by a quarter point, to 4.75%. Along with the cut, the Federal Reserve expressed optimism about the U.S. economy.
U.S. stocks are at record levels and unemployment is at record lows. Still, the Federal Reserve has cut rates three times this year. The Bank of Canada is concerned about the state of the Canadian economy but has still not cut rates once this year.
How Will This Decision Affect the Canadian Dollar?
Normally, maintaining or raising interest rates means the economy is resilient enough to withstand whatever is going on economically. Now that Canada has the highest rate in the industrialized world, it makes sense that investors, seeking higher yield currencies, would want to add the loonie to their portfolio.
At the time the Bank of Canada made its announcement the Canadian dollar was at its highest levels since February 2018 and hit a three-month high of USD$0.7662.
But, after the announcement, the Canadian dollar sold off, sliding 0.5% because of the central banks dovish tone about external headwinds on the Canadian economy.
The day after the October 30 announcement, and the Canadian dollar was trading near a two-week low. Not surprisingly, it comes at a time when the oil, one of Canada’s biggest exports, is also losing ground.
On October 31, the Canadian dollar hit further headwinds after it was announced the Canadian economy expanded less than expected in August, a paltry 0.1%.1
Canada is not an economic island. How the Canadian dollar will trade over the coming days and weeks is not as clear cut as one would normally expect.
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- “Gross domestic product by industry, August 2019,” Statistics Canada, October 31, 2019; https://www150.statcan.gc.ca/n1/daily-quotidien/191031/dq191031a-eng.htm?HPA=1.
Photo credit: iStock.com/Pogonici
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