Still Scope for CAD to Strengthen if Canadian Rates are Hiked Next Week


Talking Points

Canada was seen as almost certain to increase interest rates next week; now the markets seem less sure.

That implies scope for the Canadian Dollar to strengthen if the hike is delivered.

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The Canadian Dollar has weakened ahead of a widely expected increase in Canadian interest rates next week, lifting USD/CAD back to the 1.30 level and suggesting that traders are not so sure as they were that the Bank of Canada will decide to tighten monetary policy.

Next Wednesday, July 12, the BoC was expected to raise its overnight rate to 0.75% from 0.5% – the first increase since 2010 – despite continuing low inflation, which eased to 1.3% year/year in May from 1.6% in April. While consumer prices remain subdued, Canada’s economy grew for a sixth successive month in April despite the persistent weakness of crude oil prices – a mainstay of the Canadian economy.

Talk of an imminent rate hike became widespread after the German newspaper Handelsblatt published an interview Tuesday with BoC Governor Stephen Poloz in which he hinted strongly that he might be considering tightening monetary policy.

According to Poloz, central banks should not necessarily wait for inflation to hit the levels they like before starting to tighten monetary policy. “If we only watched inflation and reacted to inflation, we would never reach our inflation target; we’d always be two years behind in the reaction,” he was reported as saying. “So we have to look at the rest of our indicators in the models that predict inflation.”

When it comes to that prediction, Handelsblatt quoted Poloz as saying that he expects inflation to be “well into an uptrend” in the first half of 2018 as the output gap in Canada’s economy closes. According to the newspaper, Poloz downplayed recent dips in global oil prices that have pushed inflation downwards. Or, in layman’s terms: “When you are driving toward a red stoplight, you ease up on the accelerator well before you get there instead of waiting for the last second to stop,” he was quoted as saying.

Following the interview, the Canadian Dollar strengthened. But it then stabilized and has now weakened, suggesting emerging doubts about the rise that was previously seen as almost certain.

Chart: USD/CAD 15-Minute Timeframe (July 4-5)

Still Scope for CAD to Strengthen if Canadian Rates are Hiked Next Week

Chart by IG

This suggests that there remains scope for the Canadian Dollar to strengthen, and USD/CAD to fall, if Poloz and his colleagues do indeed to decide to increase interest rates next week.

— Written by Martin Essex, Analyst and Editor

To contact Martin, email him at martin.essex@ig.com

Follow Martin on Twitter @MartinSEssex

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