The Bank of Canada (BoC) is widely expected to keep its policy unchanged on Wednesday at 14:00 GMT. Recent economic data and some remarks by Governor Poloz argue for a slightly more confident tone overall, which may lift the loonie. That said, simmering trade tensions and other risks will likely keep a lid on the optimism, implying that any positive reaction may be only modest.
After hitting a soft patch earlier this year, the Canadian economy has shown clear signs of recovery in recent weeks, with incoming data being much stronger overall than what the BoC had projected in its latest forecasts. The labor market has been on a tear, with April marking the strongest month of job gains on record, and wages picking up steam. Likewise, retail sales have rebounded substantially, calming concerns around household consumption and thus around broader growth.
To be fair though, there are worrisome spots as well. Global trade tensions have escalated materially, oil prices have retreated, and the domestic housing market remains vulnerable. Perhaps more importantly, 5-year inflation expectations are declining again, which is a significant risk as the drop can become ‘self-fulfilling’ and drag actual inflation down too.
How are the markets reading all this? Admittedly, investors have focused mostly on the negatives. Bets for a rate cut have risen to signal roughly even odds for one by December, while the loonie has been trading nearly flat against the US dollar, unable to take advantage of a significant narrowing in US-Canada rate differentials in favor of Canada lately.
Against this backdrop, the BoC is unlikely to provide any strong policy signals this week, and instead may reiterate its neutral ‘wait-and-see’ stance. On the margin though, the tone of the accompanying statement could be slightly more confident, with policymakers highlighting that the economy is in much better shape than previously anticipated, even while acknowledging the external risks.
Also arguing for a slightly more hawkish spin, are some remarks by BoC Governor Poloz, who as recently as May 17 said he thinks the ‘natural tendency is for interest rates to still go up a bit’. Crucially, he made these comments after US-China tensions escalated again, but before the latest blockbuster retail sales data. In other words, he sounded confident while knowing all the bad news, but not all the good news, implying he may be even more confident in that view now.
If the BoC does strike a slightly more cheerful tone, that could boost the loonie as rate-cut bets are unwound. Looking at dollar/loonie technically, support to declines may be found near 1.3380, an area that halted multiple declines in recent weeks, with a downside break opening the way for 1.3280.
On the flipside, if policymakers focus more on the downside risks, dollar/loonie could spike up as expectations for future rate cuts grow. Advances could stall at the 1.3500 handle, and if the bulls violate that region, attention would next turn to 1.3560.
The nation’s GDP data for Q1 are also coming out on Friday.
