Published: December 18th, 2024
The Bank of Canada has dropped its base rate by 50 basis points, the second consecutive 50-point cut since October. With the rate down to 3.25 per cent, Ottawa officials are now signaling that the current rate cut cycle is complete.
“For the foreseeable future we will consider the need for additional rate reductions on an individual basis,’ said a statement on the central bank's website.
A note to investors from the National Bank of Canada said a recent rise in both the Canadian Dollar and Canadian government bonds suggests the statement provides hawkish guidance, that is, BoC decision makers will be less likely to ease rates again in the near future.
‘Bond yields are trending upwards, and CAD has recovered some ground as the BoC has provided some steer on additional rate cuts, however bonds are still well under the levels seen before Statistics Canada’s recent jobs print.’
National Bank analysts add that this means ‘the odds have increased’ that the central bank will leave rates alone at the next policy meeting.
‘Having entered the inflation neutral zone of circa 2.25 to 3.25 per cent, investors are assuming that there’s a hawkish consensus around slowing the pace of easing.’
The bank's change in posture is important for the Loonie as it tends to be highly sensitive to relative interest rate developments in the forex market.
CAD has been under pressure this year as the Bank of Canada forged ahead of its G10 peers in cutting interest rates due to a slowing economy and signs of rapid disinflation. If the Bank reconsiders, however, the Loonie could be set to appreciate.
In May, analysts at HSBC correctly predicted that BoC policymakers would skip a rate cut expected the following month to avoid diverging from the timeline of the US Federal Reserve, where rate cuts were expected to arrive later in the Summer.
The prediction came via an analyst note from HSBC’s Forex Strategy Unit. The bank’s analysts said that while many central bankers try to stay in-sync with Fed rate policy, geography and trade deals meant Canada’s central bank effectively joined at the hip to its southern neighbor.
‘Caution regarding US Fed timings will likely compel the BoC’s Governing Council to reign in any independent moves,’ HSBC said.
Looking at Canada’s economic situation on its own merits, HSBC said there was a strong case for a June rate cut. The country was experiencing disinflation and overall growth had been tepid for the year to date. Productivity gains had also been poor relative to other G10 nations.
The Loonie took a dip in early May after a print by Statistics Canada showed the country's inflation rate had dropped 2.6 per cent year-on-year in April. That was down from 2.8 per cent in March and fell below consensus expectations for another 2.8 per cent reading. The StatsCan data also supported a rate cut as the central bank’s guiding measures of core inflation all fell below expectation.
Matt Johnson, an economist at RBC, told Bloomberg that the inflation figures gave the BoC ‘flexibility to inject Canada’s economy with a bit of oxygen.’ Sustaining a tight monetary policy ‘risks limiting economic growth.’
HSBC believed a June rate cut could still happen but cautioned that worries about divergence from Washington would likely stay Ottawa’s hand.
The Canadian and American economies are tightly inter-linked through North American trade and investment treaties, meaning any distance between the policy directions of the Federal Reserve and Bank of Canada can have a larger impact on Canadian growth.
In March, One of Canada's largest banks predicted a bout of Canadian Dollar weakness over the next few months as the Ottawa central bankers faced up to the negative impact of restrictive monetary policy.
An analysis by National Bank of Canada described recent positive performance by the Loonie as ‘lukewarm’, especially when contrasted with other commodity currencies like the New Zealand and Australian Dollars.
National Bank analysts called CAD ‘the weakest amongst the strong’, blaming low performance against other commodity currencies on underwhelming economic figures.
In a note to investors the bank parsed Canadian economic data and noted areas of weakness undermining Q4 GDP growth statistics, among them confirmation that Canadian domestic demand had fallen for the first time in 12 months.
Analysts also said the tepid fundamentals of the Canada’s economy could be blamed on Bank of Canada interest rate policy, which at five per cent was draining vitality and hindering growth.
‘The downside of the BoC’s restrictive monetary policy is easier to see when you look at private domestic demand, which shrank for two consecutive quarters and has now dipped four times in six quarters.’
‘The bank has lost the justification for maintaining such a restrictive monetary approach.’
In April of 2023, the Loonie received a shot in the arm as oil prices rose by more than 8 per cent in the wake of a surprise production cut pledge by the OPEC+ group.
Markets were blindsided by an announcement from the crude cartel that saw members agree to slash nearly 1.7 million barrels of oil per day from May 2023 through to December. The Saudis agreed to the most extensive cuts, scaling back production by 500,000 barrels per day.
An analysis by Bloomberg said the move would give support to petro-currencies like CAD. While the cuts would tighten crude supply, the world economy would see a fresh inflationary jolt as a side effect.
Central banks were expected to act, meaning more rate increases than markets had priced-in before the OPEC+ bombshell. At the time (early April), USD/CAD was close to dipping below a bullish trend line after reaching some key support levels.
