Canadian Dollar Outlook: An Overview of Growth Prospects

The negative trend in global energy prices has continuedto be problematic for the Canadian economy. Persistentlyweak energy prices have caused a significant dip in monthlyGDP with May showing a contraction of -0.2% (0.2% exp).June also represented a month of contraction with GDPm/m returning a result of -0.2%. However, the Canadianeconomy is undergoing a period of re-organisation as theeffect of low energy prices start to dissipate. The Bankof Canada projects a persistent shift of investment andjobs away from the low yielding energy industry into othersectors of the economy. Subsequently, we forecast GDPto strengthen slightly throughout the later part of 2015 andfor the economy to grow around 2% in real terms.

Persistent unemployment remained a significantconstraint on domestic growth during the quarter withthe unemployment rate remaining static at 6.8%. Thestructural changes occurring within the economy, asinvestment moves away from the energy industry, is theprimary driver of the rate. This is especially evident inreduced consumer spending and confidence in regionsstrongly associated with the energy industry. However,unemployment is likely to decline in the latter part of 2015,as structural changes mean that jobs will be created inNon-Energy-Exporting (NEX) industries.

The Ivey PMI, which surveys businesses to reflect theeconomy as a whole, saw a decline to 47.9 in April.However, as the effect of lower oil prices dissipated, Mayand June posted strong PMI results at 58.2 (49.2 exp) and62.3 (55.3 exp) respectively. The results in the latter partof the quarter are representative of expansion likely drivenby fresh investment in NEX industries.

MONETARY POLICY:

The Bank of Canada (BOC) continues to take a long-termview of inflation targeting and the economy. The centralbank has not taken any action on interest rates throughoutthe quarter and subsequently, rates remain on hold at0.75%. Underlying inflation still remains below the bank’stargeted 2.0% rate, with June’s CPI y/y reporting at 0.9%.However, June’s Core CPI y/y still remains relativelybuoyant at 2.2%.

It is therefore likely that the BOC will hold off on any furtherrate cuts until they see the net result of investment capitalmoving into the non-energy sectors. It should also benoted that the current depreciation of the Canadian dollar,coupled with strong productivity growth in the labourmarkets, has significantly increased Canada’s exportcompetitiveness.Subsequently, any case for furthermonetary easing will need to be supported by a broadrange of negative indicators.

FISCAL POLICY:

The Canadian government continues to be committed toreturning the budget to surplus in the near term. Currentforecasts from the government have a small surplus ofC$1.4 billion being achieved in the 2015/2016 fiscal year.However, it should be noted that any obtained surpluswill be partially inflated by the government tapping thecontingency reserve fund, to the tune of C$10 billion, tofuel additional purchases within the budget.

The government has also sought to introduce a range offiscal initiatives to stimulate growth within the economy.The Manufacturing industry is set to benefit from a rangeof accelerated capital costallowances to the amount ofC$1.2B, in particular to support the auto parts industry.Small business has also received some fiscal supportvia a tax cut at a cost of over C$1.2B. Also, as a cornerstoneof the Canadian government’s drive to stimulateconsumer demand, a significant family tax cut wasintroduced.

FX OUTLOOK:

The Canadian dollar continues to remain depreciated,thanks to the decline of global energy prices over thecourse of the quarter. The USD now appears wellentrenched above the $1.20 level against the Loonie.

Looking ahead, the timing of the US Federal Reserve’srate rise will be a key factor in the direction of the CanadianDollar. Any move by the Fed to raise rates will fuel furtherUS Dollar strength and is likely to result in the pair tradingwell above the $1.30 level. Although we predict the chanceof a further rate cut by the Bank of Canada as limited, anydeteriorating economic conditions in the latter part of theyear, could see more easing and send the Loonie soaring.