Canadian Dollar Faces Reality-Check Mid-Week as Poloz Hits the Airwaves

Bank of Canada governor Stephen Poloz's speech on Wednesday will be the central focus for Canadian Dollar direction this week.

The Canadian Dollar could be in for a reality check this week if Bank of Canada governor Stephen Poloz warns markets that the pace of future interest rate rises will be slow in coming. 

The Canadian Dollar has been one of the better-performing major currencies over recent months thank to the BoC's new-found fondness for raising interest rates.

The BoC has hiked interest rates twice since June, taking Canada’s benchmark rate to 1% and driving a sharp upward appreciation of the Canadian Dollar.

This was after data showed the Canadian economy growing much faster than was previously expected at the end of the second quarter, with GDP expanding at an annualised pace of 4.5% in June.

But key to further CAD strength will be further moves on the interest rate; and BoC officials are being closely monitored for hints on future policy.

BoC Deputy Governor Timothy Lane last week told business leaders that future policy could depend on the strength of the CAD - if it gets too expensive they might delay further rate rises. Lane lamented the effect a strong currency can have on the Canadian economy before telling his audience, in Sakatoon, the bank is watching the currency and the economy closely to see the impact of recent policy moves.

"Reading between the lines, Lane’s message seemed to be that the BoC wouldn’t hike faster than the Fed from here forward," says Greg Andersom at BMO Capital Markets.

Market pricing suggests there is a 70% chance the BoC pulls the trigger and announces a third rate hike in December.

But economists and strategists are increasingly beginning to look again at their assumptions over Canadian rates.

Canadian Dollar Reality-Check

Will Poloz reinforce his deputy's message in a speech due to be delivered Wednesday?

“A more cautious Poloz could see the ~70% probability of a December BoC rate hike priced out as markets push back expectations of the next policy move,” says Viraj Patel, a foreign exchange strategist at ING Group.

Such an outcome would place pressure on the Canadian Dollar we believe.

"The market will await Governor Poloz’s speech on the 27th, and whether he seconds comments by Deputy Governor Lane last week over the currency," says Mazen Issa, a strategist at TD Securities. "We view last week’s CPI as reinforcing the BoC’s narrative of a closed output gap and pick-up in underlying inflation, but the CAD should take its cue from the speech and GDP data later this week. We view pre-Sep BoC levels near 1.2370/1.2450 as strong resistance."

“Deputy Governor Lane's comment that officials are "paying close attention" to the economic impact of higher short-term rates and a stronger CAD supports our view of a pause in the BoC's hiking cycle for the remainder of this year,” says Patel at ING.

Patel has forecast the USD/CAD rate may see a return to the 1.2470 level if Poloz doesn’t sing like a hawk Wednesday and if the latest Canadian GDP number, due Friday, points to a softening of growth during the recent quarter.

“This would inject a bit of realism into the domestic economic recovery and support a more cautious policy outlook,” he wrote in a note.

Patel isn’t alone in his sentiments as some economists have been predicting a BoC pause of late, while one has even forecast that the Canadian central bank may even reverse its recent interest rate hikes once into 2018.

“The brilliance of first-half GDP growth not only brought on a well justified tightening, but it’s blinded investors to factors that are likely to materially delay a further round of rate hikes,” says Avery Shenfeld, chief economist at CIBC Capital Markets. “Since the Canadian Dollar has been heavily driven by interest rate differentials, look for Governor Poloz to drop further hints that additional rate hikes will be slow in coming"

Last week’s speech by Lane effectively putting the market “on notice” that it may have overinterpreted the degree of hawkishness among rate setters, according to Shenfeld, while a repeat performance from Poloz will almost certainly reduce the odds of another rate hike this year.

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But another economist has gone further than Shenfeld and any others.

Paul Ashworth, chief North American economist at Capital Economics, sees the Canadian economy heading for a slowdown and has flagged the possibility of a downturn in the housing market, which has seen double digit price growth throughout the year. 

"After a strong growth performance so far this year, Canada's economy looks on the verge of a downturn as the housing boom turns to bust...We expect GDP growth to slow sharply next year, prompting the Bank of Canada to reverse its tightening cycle," Ashworth says. 

The Canadian Dollar was quoted 0.05% lower, at 0.8079, against the greenback in London Tuesday morning. This makes for a USD/CAD rate of 1.2373. The Pound-to-Canadian-Dollar rate was up 0.17%, at 1.6696, during early trading.