Canadian Dollar Extends Losses after GDP Disappointment Casts Doubt over September Move from the BoC

-Canadian Dollar weakens after crunch June GDP report disappoints.

-Analysts were eyeing scope for solid number to yield Sept rate hike.

-Friday's NAFTA deadline is still looming, could yet add to CAD losses.

Image © Bank of Canada, Reproduced Under CC Licensing

The Canadian Dollar extended losses Thursday after official data showed economic growth picking up sharply in the second quarter but at a slower than expected pace, which may now cast doubt over whether the Bank of Canada goes ahead with another interest rate rise in September.

The Canadian economy stalled to a halt during June, with GDP registering a 0% change, although the quarterly pace of growth still picked up from 0.4% at the start of the year to 0.7% for the three months to the end of June.

This saw the Canadian economy growing at an annualised pace of 2.9% during the second quarter, up from 1.3% previously but below the consensus for a 3% expansion.

Statistics Canada says the expansion was driven mainly by an increase in export volumes which, up by 2.9%, rose at their fastest pace for four years. Household spending and business investment both also rose during the period, albeit at a lesser pace than international trade.

"The in-line GDP figures, and flat June, are enough reason for the Bank of Canada to wait until October to hike again, particularly if we don't get a clear and favourable outcome to NAFTA and the tariffs on steel/aluminum are left in place," says Avery Shenfeld, chief economist at Toronto-headquartered 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, or hints of them being in the cards, 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.

Financial markets have been wrestling with the question of whether the Bank of Canada would next raise interest rates in September or in October, although Thursday's data appears to have settled the debate in favour of the latter. 

"Given the repricing of the BoC and the positive flow of NAFTA headlines, we think the loonie has priced in a lot of the good news," says Mark McCormick, North America head of FX strategy at Toronto-headquartered TD Securities, who advocates using any dips in the USD/CAD rate toward 1.29 as a buying opportunity. 

The USD/CAD rate was quoted 0.47% higher at 1.2964 following the release after extending an earlier 0.19% gain while the Pound-to-Canadian-Dollar rate was 0.41% higher at 1.6887 after adding to an earlier 0.04% gain. The Loonie was also lower against all other G10 currencies barring the New Zealand Dollar.

"We think there are potential upside risks to the CAD as markets are underestimating the odds of a 25bp rate hike at the next meeting. In our view, the July labour market and inflation reports justify Governor Poloz delivering a second successive rate hike in 2018. USD/CAD to test the 1.2900 level," says Petr Krpata, chief EMEA strategist at ING Group.

The Bank of Canada raised its interest rate by 25 basis points to 1.5% back in July, citing mounting inflation pressures as well as a robust and improving performance from the economy.

Canadian inflation hit 3% during the same month, which is substantially ahead of the BoC's 2% target, although the Bank itself said this strength is unlikely to last for very long. The BoC has raised interest rates twice in 2018 and four times in the last 12 months.

Pricing in interest rate derivatives markets, which enable investors to protect themselves against changes in interest rates while providing insight into monetary policy, implied a September 05, 2018 cash rate of 1.54% Thursday morning.

Given the cash rate would sit at 1.75% if the BoC raised it again, that above number suggests markets see only a minimal probality of another rate hike next week. The implied rate for October 24, 2018 is 1.70%. 

Thursday's GDP data was released less than a day ahead of a US-imposed deadline for Canada to agree to the terms of a new North American Free Trade Agreement negotiated almost exclusively between the US and Mexico.

A Canadian rejection of the deal could see the White House set the clock ticking on a US withdrawal from the current trade pact. This would deal the Loonie a severe blow and may be enough to scupper any further Bank of Canada interest rate rises in 2018.

TD Securities analysts previously estimated a US withdrawal from NAFTA could see the Canadian Dollar fall by 20% as markets would be forced to mark down their expectations for Canadian economic growth and interest rates over the longer term. The USD/CAD rate is already 4% higher thus far in 2018.

"The publication of Q2 GDP this afternoon will get lost in all this," says Antje Praefcke, an analyst at Commerzbank. "If an agreement is reached by tomorrow evening CAD might record a relief rally towards 1.28 in USD-CAD until tomorrow evening ahead of the weekend. Otherwise the cross is likely to move back up towards 1.30." 

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