At its March 2 policy meeting, the Bank of Canada (BOC) maintained its benchmark short-term interest rate at an all-time low of 0.25 percent, but it’s comments were a bit more hawkish than at the January meeting. What does this mean for the Canadian dollar?
The BOC’s benchmark rate been at its current level since April 2009, and is not expected to change until the end of the second quarter of this year. The BOC said that the rate would remain steady as pledged “conditional on the current outlook for inflation.” Most analysts feel it will move up a quarter point by July, so we have two more meetings with no change likely.
That being the case, in the near-term I expect the Canadian dollar to continue trading in the range it’s been in for several months. But when the BOC does decide to start raising rates, an upside breakout is likely, similar to what we’ve seen in the Australian dollar.
The BOC targets the overnight lending rate among banks. Whenever the economy starts to speed up and things are going well, the BOC will typically raise the rate in an effort to lower inflation. During poor economic times, the BOC will lower rates to spur investment and spending. The target interest rate can’t realistically go any lower than where it is now.
Consumer Price Index (CPI), which represents a basket of products within the economy, has climbed slowly to 1.9 percent in January, on a year-over-year basis. The BOC’s inflation target is between one and three percent, so the inflation rate is currently at a sweet spot, sitting right in the middle of that range. Fourth-quarter gross domestic product (GDP) stood at 5 percent.
Core CPI 2004 – 2010
BOC Commentary Changes
On the Bank of Canada Web site, you can view rate changes and commentary, and even get email notices. Monetary policy changes are public information and are released every six weeks. The comments tend to be similar from meeting to meeting, but if you read closely you can see subtle differences.
Compared with the prior meeting on January 19, the comments released for the March 2 policy meeting were shorter, more succinct, and more hawkish. Hawkish means rates are expected to rise, while dovish means they are expected to fall. This latest report was definitely hawkish, and the BOC is slowly and surely bracing the markets for an increase in rates as the economy picks up. I think they will brace the markets even further at the next meeting in April, because it’s more prudent to ease higher rates into the market than create a shock.
Taking a closer look at the changes in the comments between the two meetings, you will see how policymakers are setting the stage for an increase. Compare and contrast the statements below from the BOC’s January and March policy meetings.
January Meeting
“The global economic recovery is under way, supported by continued improvements in financial conditions and stronger domestic demand growth in many emerging-market economies. While the outlook for global growth through 2010 and 2011 is somewhat stronger than the Bank had projected in its October Monetary Policy Report, the recovery continues to depend on exceptional monetary and fiscal stimulus, as well as extraordinary measures taken to support financial systems.”
“Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target.”
“While the underlying macroeconomic risks to the projection are roughly balanced, the Bank judges that, as a consequence of operating at the effective lower bound, the overall risks to its inflation projection are tilted slightly to the downside.”
March Meeting
“The ongoing global economic recovery is being driven largely by strong domestic demand growth in many emerging-market economies and supported in advanced economies by exceptional monetary and fiscal stimulus, as well as extraordinary measures taken to support financial systems.”
“Conditional on the current outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target.”
“The Bank judges that the main macroeconomic risks to the inflation projection are roughly balanced. Core inflation has been slightly firmer than projected.”
What I see as the big difference in the March report is that the BOC is no longer looking at inflation on a big-picture level, they are looking at it on a day-by-day basis. Instead of just mentioning the inflation outlook, in March, they mentioned the “current inflation outlook.” In January, they weren’t too concerned about inflation. In March, they took out the phrase they used in January that inflation was “tilted slightly to the downside.” The BOC also said core inflation was slightly stronger than expected. That looks hawkish to me.
Canadian Dollar
These policy shifts have implications for the Canadian dollar, which has been trading in a range of roughly 94c – 96c. For several months, many traders have been successfully selling Canadian dollar futures at the top of the range, and buying near the bottom. The dollar rose to 97c after the BOC news and strong GDP, but I don’t see much further on the upside. I think the market got the best news it could get. Although we didn’t see a rate increase, the market was not expecting it. We have the facts, so it’s time to sell as the news pushed the Canadian dollar too high, in my opinion. Once rates start moving up, this range will not be in play.
On the charts below, the Canadian dollar is represented by the candles in red and blue, while the Australian dollar has black and green candles. If you compare the Canadian dollar with the Australian dollar, you can see the Aussie dollar had a lot of growth and then shot up in October. That’s when the Bank of Australian raised its key interest rate. They have had four consecutive rate increases, moving from three percent to four percent. Since the rate hikes, you can see how the Canadian dollar has been tracking the Aussie dollar’s moves. I think the Canadian dollar is likely to trade even closer to the Aussie dollar in relative terms if the BOC raises rates, and move up to par. In the meantime, I see the Canada dollar pulling back into its established range.
Drew Shaw is a Senior Market Strategist based in Lind-Waldock’s Toronto office, and is serving clients in Canada. If you would like to learn more about futures trading you can contact him at 877-840-5333, or via email at dshaw@lind-waldock.com.
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