Canadian Dollar Responds To A 75bps BoC Rate Cut And Dour Forecast

It has been the rule over the past few months that interest rate cuts (even massive ones) would generate little response from the currency market or even ones that were seemingly contradictory. This was not the case for the Bank of Canada’s rate decision.

Unlike the Fed, ECB, BoE, and others, the Canadian monetary authority was one of the few central banks considered by the market to have room in growth and inflation to keep a reserved pace in their unfolding dovish policy regime. With a 50 basis point rate cut forecasted by 20 of 23 economists polled by Bloomberg and an equally reserved forecast priced in by the market, the greater than expected 75 basis point reduction along with dovish commentary over future conditions would ultimately lead to a sharp drop in the Canadian dollar across the board.

Beyond the initial surprise in the bigger-than-expected rate cut, the statement was equally disconcerting for loonie traders. Setting a similar tone to their international counterparts, the BoC remarked on concerns over the path of growth, inflation and the financial markets. Expectations for economic activity were the most alarming with a view that the deteriorating in global growth was broader and deeper than expect, leading their outlook to have been lowered ‘significantly.’ More unsettling was the offhanded suggestion that the local economy was "entering a recession." While this was likely an outcome priced in by fundamental traders, the strong third quarter GDP report allowed many skeptics to linger. In regards to price pressures, the central bank noted that core inflation may be slower than forecasted going forward. This will be the next contingency for rate watchers. Like many other central banks, the BoC may soon find itself within arms reach of a zero interest rate policy while tumbling prices leaves Governor Mark Carney and crew few options to stabilize conditions.

After a number of much larger cuts from various central banks (up to 150 basis points), easing that has brought many benchmarks to near zero and now forecasts for monetary policy to reach its limits while conditions continue to worsen, why would the Bank of Canada’s relatively modest 75 basis point rate cut move the markets so clearly? Speculation. For the other major central banks, the sharp cuts and dour forecasts have been built up gradually by commentary and supplementary data. In Canada, however, traders were holding out with lagging economic indicators and comparatively optimistic forecasts for Canadian growth and healthy financial market activity. Clearly, in this event, such expectations were blown away. So, now we must ask, will the Canadian dollar be open to a similar surprise and revaluation in the future? Unlikely. After two 75 basis point rate cuts and forecasts that have put the domestic economy on pace for a recession, the BoC has been turned into the G10 fold. 

DailyFX

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