Canadian Dollar Sinks After BoC Rate Hike: Analysts are Giving their Views on What Happens Next

Analysts give their views on what Wednesday's interest rate rise might mean for the Canadian Dollar going forward.

Canadian Dollar exchange rates remain deep in the red after the Bank of Canada raised interest rates on Wednesday for the third time in the last year.

The Bank of Canada raised its official cash rate by 25 basis points to 1.25%, in a move that was widely expected by the market.

Rate setters cited a recovery in inflation and an economy that was close to full capacity as being behind the decision.

Foreign exchange, interest rate derivatives and bond markets had called the move long before it was announced, which meant there was little to be gained for the Loonie from the BoC actually going ahead with the hike.

On the downside for Canadian Dollar bulls, the BoC warned that the renegotiation of NAFTA is deterring business investment and that the contribution to economic growth from investment will be lower than it otherwise might have during the coming years.

....The Wall will be paid for, directly or indirectly, or through longer term reimbursement, by Mexico, which has a ridiculous $71 billion dollar trade surplus with the U.S. The $20 billion dollar Wall is “peanuts” compared to what Mexico makes from the U.S. NAFTA is a bad joke!

— Donald J. Trump (@realDonaldTrump) January 18, 2018

Governor Poloz also flagged the broader risks to the economic outlook stemming from the NAFTA negotiations. This comes after reports that the Canadian government is becoming increasingly convinced President Donald Trump will pull the US out of the agreement.

The Canadian Dollar sank deep into the red in response to the statement, likely because markets have now judged earlier expectations of further interest rate rises to come later in 2018 as being too ambitious.

The USD/CAD rate was quoted 0.09% higher at 1.24456 Thursday morning while the Pound-to-Canadian-Dollar rate was marked 0.03% higher at 1.7208.

Both exchange rates are higher than they were before the BoC’s announcement.

Analysts give their views below on what they think the BoC's decision will mean for the Canadian Dollar going forward.

Readers can learn more about why the Bank of Canada raised its interest rate here.

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Analyst Views: 

Bipan Rai, macro strategist, CIBC Capital Markets

"The Bank of Canada hiked rates, but it’s the language around NAFTA that colours the statement as dovish."

"The degree to which the Bank is concerned is ‘increasing’, which at the margin suggests that the overly aggressive BoC pricing this cycle needs to be amended. The market is currently pricing in around 17bps for the April BoC meeting."

"For now, risks are to the upside for USD/CAD, but our preference remains to play this via EUR and JPY."

"CAD/JPY is testing the trend line off of the June 2017 low and we expect that a break below the 88.35/36 area is meaningful."

"An extension below the 86.70 mark will confirm a double top formation with a measured move towards 82.00 ahead of our target at the 80.00 level."

"We recommend a strategic CAD/JPY short below 86.70 to target 80.00 with a stop at 89.15."

Tim Quinlan, Senior Economist, Wells Fargo

“The inflation backdrop should be adequate to justify further rate hikes, but an over-leveraged consumer and lingering worries about NAFTA will be among the key hurdles between the BOC and an untrammelled path to higher short-term interest rates in Canada.”

“At the same time, the effect of 2017’s two quarter-point rate hikes is already being felt by Canadian households.”
“Given high levels of household indebtedness in Canada, it bears closely monitoring the impact of higher rates on the Canadian consumer.”

“Canada’s household debt to GDP ratio reached 97.0 percent in Q3, and household debt levels lead the OECD on a per capita basis.”

“Concerns about a United States withdrawal from NAFTA still linger, with mixed signals from the White House. This risk may also prompt the BoC to hold off rate hikes given the potential negative economic effects of higher tariffs with Canada’s largest trading partner.”

“We have been (and remain) on the low-end of the consensus expectation for short-term rates in Canada. Our forecast of 1.50 percent for the overnight rate at year-end means that there is only scope for one more rate hike this year.”

Krishen Rangasamy, economist, National Bank of Canada

“A dovish interest rate hike from the Bank of Canada was always in the cards. The central bank, which previously said its actions are data-dependent, was forced to adjust its stance amidst strong data. But it tried to pare back expectations of additional rate hikes via cautionary language including concerns about NAFTA-related risks and uncertainty about inflation.”

“The main source of concern to the BoC is trade: “as uncertainty about the future of NAFTA is weighing increasingly on the outlook, the Bank has incorporated into its projection additional negative judgement on business investment and trade.”

"The BoC said that while higher interest rates are expected to be warranted, “continued monetary policy accommodation will likely be needed to keep the economy operating close to potential."

"The BoC again mentioned it will be cautious in making future adjustments to the policy rate given the economy’s sensitivity to interest rates amidst high household indebtedness."

“Business contacts are telling the BoC that the current uncertainty is already affecting investment decisions. Some firms are reportedly choosing to postpone investment, while others are investing south of the border.”

“In either case, this is a negative for the current economic outlook and the reason why the Bank decided to incorporate into its projections additional negative judgement on business investment and trade.”

Marshall Gittler, chief strategist, ACLS Global

"CAD was remarkably stable – my reading for USD/CAD this morning was only 2 pips off of yesterday morning’s level."

"The hike in rates initially sent USD/CAD sharply lower, but on further reflection, the Bank of Canada’s warnings about NAFTA and continued caution about future rate hikes sent it right back to where it had started."

"Still, the pair had risen considerably in the run-up to the announcement so this can be seen as ratifying the higher loonie. I think the rising trend for CAD could continue as long as the data keeps improving."

Avery Shenfeld, chief economist, CIBC Capital Markets 

"Today's rate hike was a rear view mirror move, but the Bank of Canada hints that the view out the front window isn't quite as sunny."

"Canada did so well in 2017 that it left little slack in labour markets or capacity in its wake, easily justifying a quarter point hike today, and we share the Bank of Canada's view that higher rates will be needed over time. But perhaps not as fast and furious as the market was starting to think."

"The Bank's statement put NAFTA uncertainties right up front in their statement, and also explained that "monetary accommodation" (ie. rates at stimulative levels) will be needed to reach their growth and inflation forecasts, reasserting the need to be cautious in how fast they hike ahead."

"Overall, this was a dovish statement relative to the minimum degree of optimism needed to justify a rate hike today, and could put some downward pressure on 2 year yields and the value of the C$."

Stephen Galllo, head of G10 FX strategy, BMO Capital Markets 

"This meeting has two main scenarios: either the BoC hikes with accompanying communication that seeks to soften the market impact of the hike (a dovish hike) or else it stands pat and lays the groundwork for a March hike (a hawkish hold)."

"We would also point out that it can be difficult to wordsmith a dovish hike because one typically writes to support the decision. As a consequence, we could end up with a hawkish hike in the written materials that is softened later in the press conference."

"We would expect a bigger reaction to a non-hike than a hike because it would be a bigger surprise, but we don’t think the market has a huge short USDCAD position that would trigger a cascade of stops."

"We think USDCAD will still move lower on a hike despite it being expected. That is one of the effects of the BoC having been somewhat unpredictable in the past. The market thinks the BoC will hike but has largely chosen to react to the decision rather than put trades on beforehand."

Mark McCormick, Mazen Issa, FX strategists, TD Securities

“It’s Bank of Canada decision day, and we look for a 25bp hike.”

“We acknowledge the bubbling NAFTA concerns have thrown a monkey wrench into the decision that could lead to a surprise hold, but the data is hard to ignore for this “data dependent” central bank.”

“Our base case of a rate hike may offer a knee-jerk boost to CAD but rich valuations, stretched positioning, and looming NAFTA risks favour buying into USDCAD dips near the recent lows.”

“We view the risk/ reward as more attractive to play CAD on the short side particularly on the cross vs. NOK, EUR and JPY.”

“1.2330/60 should be big barrier of support for USDCAD with greater upside potential above observed just shy of 1.26 on a dovish outcome.”

Mike Morgan, chief Americas economist, Standard Chartered

“While the market-implied probabilities ahead of the 17 January Bank of Canada meeting suggest that a 25 basis point hike is almost unanimously expected, we think that the possibility of an unexpected “unchanged” decision is higher than many think and thus a much closer call than consensus implies.”

“Arguably the economic backdrop facing the BoC now compared with December’s policy meeting is little changed. Yet the BoC made the case for caution while leaving rates unchanged then.”

“Governor Poloz has warned publically of uncertainties posed by the NAFTA negotiations as well as increasing sensitivities the economy may have to higher interest rates. Neither of these risks has diminished since December.”

“If we are wrong, we think a hike would be ‘dovish’, couched in cautious language, leaving expectations for three or more hikes in 2018 too aggressive.”

Ben Randol & Adarsh Sinha, FX strategists, Bank of America Merrill Lynch 

“Our call is that the BoC will follow through with a hike at the January meeting. If delivered, USDCAD may sell off by perhaps temporarily given the event is about 80% priced."

"If BoC opts to wait given NAFTA risks and remaining uncertainty regarding the data, we think USDCAD could potentially rally by around 2% in a straight line.”

Derek Halpenny, European head of global markets research, MUFG

"The justification for a rate hike today from the Bank of Canada seems quite compelling."

"The probability of a rate hike today according to Bloomberg calculations stands at 90% this morning which means CAD direction may well be determined by the contents of the Monetary Policy Report and what that signals for future moves."

"The only reason for caution is of course the continued uncertainty surrounding the NAFTA negotiations....we doubt NAFTA uncertainty will hold the BoC back."

"Given yields in the US have been moving notably higher the case for USD/CAD to drop on rate spread moves is not compelling."

"We also view crude oil prices as toppy and with the NAFTA negotiations ahead next week, we believe a pretty hawkish MPR will be required to lift CAD notably from current levels on a sustainable basis. So we are somewhat cautious over the scope for notable CAD gains from here."

Antje Praefcke, analyst, Commerzbank

"That will be a narrow vote in Ottawa today. A 25bp rate hike to 1.25% today is fully priced in by the market. That means that the CAD has little upside potential if the Bank of Canada (BoC) decides in favour of +25bp."

"We see some reasons why the BoC can take its time with the next rate hike. If the BoC does not deliver today, the CAD will suffer a massive blow and USD-CAD will rise back towards 1.26."

"The BoC could continue its hiking cycle as early as Wednesday and justify this decision with new forecasts in its new monetary policy report....In this case, the market is likely to focus again on the 1.20 mark in USD-CAD in the coming weeks."

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