Canadian Dollar Advances after August GDP Data Keeps Bank of Canada on Track to Raise Rates Again in January

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- CAD advances after data shows economy marching on in August.

- Robust growth keeps the BoC on track for January interest rate rise. 

- But international events as important for CAD outlook as the domestic. 

The Canadian Dollar advanced against most currencies Wednesday after official data revealed the economy continued to grow at a healthy pace in August, keeping the Bank of Canada (BoC) on track to raise rates again in January. 

Canadian GDP grew by 0.1% during the August month which, although down from the 0.2% seen in July, was in line with market expectations. 

A rebound in activity across the mining, quarrying, oil and gas sectors was the greatest contributor to growth during the August month, although the expansion was also robust in the financial and insurance services sectors. 

Outside of those areas, the economy's performance was rather tepid with 12 out 20 industrial sectors having seen output decline in August, according to Statistics Canada. 

"Over the past year, GDP has advanced at a 2.5% pace, and the BoC’s objective is to slow that to 1.9% by 2020. That to us doesn’t seem consistent with the need for a lot of interest rate tightening, unless a case can be made that the economy was otherwise on the verge of accelerating," says Avery Shenfeld, chief economist at CIBC Capital Markets. 

Currency markets care about the GDP data because economic growth has a direct bearing on inflation and it is changes in consumer price pressures that central banks are attempting to manipulate when they tinker with interest rates, which are themselves the raison d'être for most swings in exchange rates.

Changes in interest rates are only normally made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"We’re sticking to our call for the next hike to be in January, as we’ll need to see some 0.3% in this series, or a surge in employment, to give the BoC a reason to hike in December," says Shenfeld, in a note to clients Wednesday.

The USD/CAD rate was quoted 0.15% higher at 1.3136 Wednesday and is up 4.4% for 2018 while the Pound-to-Canadian-Dollar rate was 0.49% lower at 1.6748 and has declined 1.16% this year.

The Loonie traded a fraction higher against all G10 currencies other than the Pound, U.S. Dollar and Swiss Franc on Wednesday.

The Bank of Canada (BoC) raised its main interest rate by 25 basis points to 1.75% in October, the third rate hike in 2018, and signalled that further rate hikes will follow over coming months.

It said the cash rate will have to rise all the way up to the so called "neutral" level, which it estimates to be between 2.5% and 3.5%, over coming quarters.

The "neutral" rate is the equilibrium level at which rates themselves neither encourage nor restrict economic activity. It is not fixed at a particular point and policymakers do not know exactly where it is at any one point in time.

As things stand, a January rate hike is almost fully priced into the current market, which explains the Loonie's limited response to Wednesday's data. 

Howevever, the outlook for the Canadian currency in 2019 depends not only on what the Bank of Canada does, but also on monetary policy developments elsewhere in the world.

Both Canadian and U.S. economies are growing at rates close to 3% and inflation in each country is running close to official target levels, enabling both major North American central banks to keep raising interest rates.

This has lifted the Canadian and U.S. Dollars against most other currencies during the 2018 year.

Meanwhile, both the European Central Bank and Bank of England are being stymied from raising rates by low inflation and the ongoing Brexit negotiations respectively.

Central banks in the Antipodes, despite presiding over economies that are still growing at a robust pace, are also being prevented from lifting their own interest rates by persistent below-target inflation.

That has contributed to severe losses of -8.9% and -7.4% respectively for the Australian and New Zealand Dollars in 2018.

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