"CAD-unfriendly" Budget Will Lead to More Canadian Dollar Depreciation says National Bank

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National Bank of Canada says the Canadian Dollar's trend of depreciation is likely to continue owing to economic weakness in Canada, the prospect of lower interest rates and a "CAD-unfriendly" federal budget.

"As if this interest rate situation wasn't CAD-unfriendly enough, let's not forget the recent federal budget, which raised the capital gains inclusion rate from 50% to 67%, effective June 25," says Stefan Marion, an economist at NBC.

In a monthly exchange rate forecast update, he explains Ottawa expects to see significant profit-taking between now and the tax deadline as investors decide to avoid the higher taxation.

This is a "development that could prompt the sale of CAD assets," warns Marion.

"This will serve to discourage investment, demotivate Canadians from getting into business in the first place or working hard to grow a small business to a medium-sized business," said the Canadian Federation of Independent Business (CFIB) following the budget announcement.

When screened over the course of 2024, the Canadian Dollar is a mid-pack performer in the G10 currency space, which actually reflects a nearer-term decline in performance. At one stage, it was tracking USD outperformance quite closely as investors assumed ongoing synchronicity in the Canadian and U.S. economies.

However, although the U.S. continues with its exceptionalism theme, Canada is starting to struggle.

"Despite a resilient U.S. economy, external trade is not improving," says Marion. "Economic weakness in Canada certainly argues for a divergence in interest rates between Canada."

The Bank of Canada is widely expected to cut interest rates this summer, while the U.S. will likely cut later in the year, creating a divergence in interest rates that are unfavourable to CAD.

"Will the 1.38 resistance be broken? We think so," says Marion.

Oil prices are also important for the outlook, with National Bank now expecting a WTI oil price of USD 75 in their forecasts; "we still see the USD/CAD exchange rate moving above 1.40 in the second half of 2024 in 2024."

National Bank is also concerned about Canada's inability to keep up with migration levels. Economists note Q1 GDP is currently on track to grow 2.5% annualised, but "this is underwhelming given record population growth (3.7% annualised) in the first three months of 2024. As a result, GDP per capita continues to trend down and is now 3% below its peak of September 2022. A decline of this magnitude has never been seen outside of a recession," says Marion.

The U.S. Dollar-Canadian Dollar exchange rate is forecast to peak near 1.42 by the fourth quarter. The Pound to Canadian Dollar exchange rate is forecast to close the year nearer 1.71 and the Euro to Canadian Dollar at 1.46.