Canadian Dollar Outlook Dims After Economy Stalls In July

July's GDP number vindicates Bank of Canada policymakers for having begun to warn markets about expectations over future rates.

The Canadian Dollar slumped during noon trading Friday after data showed the economy stalling to a halt during July.

Canadian GDP was unchanged during the month against economist forecasts for growth of 0.1%. This was after a bumper 0.3% number in June.

More than half of the 20 sectors tracked by Statistics Canada showed no growth during the month while a contraction in oil and gas activity weighed heavily on the overall result.

“The flat reading was a tick weaker than the consensus was looking for, although the miss was driven entirely by the sometimes volatile oil and gas sector,” says Nick Exarhos, an economist at CIBC Capital Markets.

The number vindicates Bank of Canada policymakers for having begun to warn markets about overzealous expectations over further rates to come. 

“We suspect that the slower start to Q3 gives us the flavour of things to come, with our forecast for the back half of the year tracking half the pace seen at the start of 2017. That's another reason why we see the Bank of Canada using a more gentle hand with tightening from here,” adds Exarhos.

The Pound-to-Canadian-Dollar rate pared earlier losses immediately after the release, to be quoted at 1.6681, down just 0.10% on the session. The Loonie gave earlier gains back across the entire G10 basket, with the USD/CAD rate swinging into the black to be quoted 0.07% higher, at 1.2447. 

“Poloz's cautious stance earlier this week does not rule out rate hikes altogether but the bar is higher. We think 1.25 in USDCAD should prove formidable resistance and an opportunity to fade,” says Mazen Issa, a foreign exchange strategist at TD Securities.

The Canadian Dollar enjoyed a strong run throughout the summer months but has faltered in the latter half of September after policymakers began muttering about currency strength and a need to be vigilant about the effect of two recent rate hikes on the economy.

Canada’s benchmark interest rate now sits at 1% after the Bank of Canada raised rates in June and then followed through with a surprise hike in September.

“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 Viraj Patel, a foreign exchange strategist at ING Group.

Wednesday saw BoC governor Stephen Poloz echo the recent sentiments of his deputy, Timothy Lane, when he used a speech on monetary policy and data dependence to warn that he and other policy makers are still watching the Loonie closely.

“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.

Shenfeld forecasts the BoC will now pause in its hike toward higher rates, which could be a source of downside for the Dollar, while one economist has forecast that the BoC may even reverse course next 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,” wrote Paul Ashworth, chief North American economist at Capital Economics, in a September note. “We expect GDP growth to slow sharply next year, prompting the Bank of Canada to reverse its tightening cycle.”