At the July monetary policy meeting, the Bank of Canada (BoC) suggested there was little prospect of any near-term policy change. Officials highlighted the domestic improvements since the weakness in the last quarter of 2018 and first quarter of 2019.
The second quarter GDP report underlined that economic strength is growing by a very robust 3.7 percent the 3 percent consensus figure. It is this decent domestic performance that has so far left the BoC reluctant to follow other central banks signalling dovish intentions.
That being said, the major contributor of GDP was exports that grew hugely by 13.4 per cent, largely due to the re-starting of oil fields whereas consumer spending grew just 0.5 per cent. Non-residential business investment actually contracted 16 percent while residential investment rose for the first time in six quarters.
Even though the BoC did not suggest any near-term policy change, they did recognise the threat posed by global trade tensions. In turn, this risks curbing manufacturing activity, weakening investment and dampening commodity prices.
These trade tensions have escalated in recent weeks while the global slowdown showing little sign of narrowing. Together with a softer tone seen in U.S manufacturing data, the news flow all points in the direction of fading Canadian economic momentum.
Softer economic data point to BoC rate cut
Canada has already experienced two consecutive months of falling payrolls, and with business confidence coming under pressure given the global backdrop, more losses may be seen in the months ahead. A rate cut at next week's meeting is an outside possibility, but the imminent federal election near the end of October and election campaigning getting into full swing make that doubtful. At the moment, the market is pricing in around a two-thirds probability of a rate cut in October, whereas the latest survey of analysts by Bloomberg continues to peg stable rates through this year and next.
The Canadian dollar still weak
Trade tensions seems to be the root of all evil for the Canadian dollar given its negative impact on the three main drivers of the currency.
In the past three months, the Canadian dollar vs the U.S dollar has been very sensitive to any global risk sentiment. A high-yielding activity currency such as the Canadian dollar is naturally hit by rising risk aversion, and the extraordinary rally seen in June and July is now experiencing the fall.
Despite OPEC’s efforts to revive the battered oil market, trade tensions are fuelling fears of a global slowdown on the demand side, keeping crude prices on the end of the spectrum. Internally, the state of Alberta has extended its output gap, but this has done little to help the currency.
Lastly, the BoC’s rate expectations have been under pressure as trade wars escalated and markets are currently pricing in one rate cut by the end of the year.
In light of this, trade tensions continue to be a big question mark on the currency outlook and will inevitably be the key driver for the currency moving on.
Also, a rate cut in October by the BoC is mostly in the price and may have limited downside impact on front-end rates.
Trade tensions have been the main factor preventing USD/CAD to recouple with the short-term rate spread that would still suggest a weakening of the pair ahead. The rate differential is expected to prevail as a driver in the longer term.
This article was issued by Maria Fenech, Credit Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.