GDP Data Shows Canadian Dollar's Rally Built on Weak Fundamentals

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The Canadian Dollar is the best-performing G10 currency on the day it is reported the Canadian economy grew at an annualised rate of 2.1% in Q2, which is above the 1.8% rate expected by the consensus of economists and the Bank of Canada's forecast for 1.5%.

However, the details of the GDP report were not flattering and suggested the Bank will have to cut interest rates much further, suggesting CAD's current short-term rally will have its limits.

Monthly GDP for July was flat at 0%, down from June's 0.2% growth, and economists say GDP reading for the third quarter is tracking well below the Bank of Canada's forecast.

"Take a look under the hood, and Canada’s growth engine looks to be sputtering," says Randall Bartlett, Senior Director of Canadian Economics at Desjardins Bank. Bartlett says his tracking of annualised real GDP growth is now in the range of 1.0% and 1.5% in Q3. This is well below the 2.8% forecast by the BoC in its July 2024 Monetary Policy Report.

"A recovery seems unlikely. Despite the start of interest rate cuts, households renewing their mortgages continue to face a significant interest payment shock," says Matthieu Arseneau, an economist at National Bank of Canada (NBC). "Interest rates in Canada remain too restrictive."

NBC thinks the Bank of Canada will cut interest rates sharply in the coming months, including by 25 basis points at next week's decision.

Despite the prospect of further rate cuts, the Canadian Dollar is enjoying a short-term spell of outperformance: the GBP to CAD exchange rate (GBP/CAD) was unable to hold the 1.78 resistance level and has now fallen for three days in succession reaching 1.7720.

Canadian Dollar strength is more pronounced elsewhere, with EUR/CAD down seven days in a row at 1.4923 and USD/CAD down 2.30% in August.

CAD's recovery will be challenged by another rate cut next week that should be accompanied by guidance from the Bank of Canada that alludes to further cuts.

Friday's GDP data showed why further cuts are necessary, with corporate profits shown to be struggling to recover. NBC's Arseneau says there are also increasing signs of widespread overstaffing, "companies don't just seem to have an excess of workers, their inventories also seem overfilled."

Although the domestic picture is dour, the Canadian Dollar has been boosted by the prospect of interest rate cuts south of the border in September. This has boosted global investor sentiment and raised expectations that support for the U.S. economy will boost Canada's prospects.

Markets had also built a notable 'short' position in CAD, betting it would continue to fall. A washout of these positions could explain recent outperformance.