Bank of Canada stands pat, USD/CAD does not

Official economic optimism is in short supply everywhere. The Bank of Canada's (BoC) guarded invocation was enough to drive the Canadian dollar to a 33-month high of 1.2603 at the release of the December rate decision on Wednesday.

There had been no market expectation for a change in either the 0.25% overnight lending rate or the C$4 million a week in quantitative easing purchases. Journalists had speculated that in light of the weak December employment report the bank might opt for a reduction less than the standard 0.25%.

Bank of Canada overnight lending rate

What was unforeseen, given that much of the Canadian economy is locked down, was the bank's straightforward optimism about the vaccine and its impact on second half growth.

“Assuming restrictions are lifted later in the first quarter, the Bank expects a strong second-quarter rebound. Consumption is forecast to gain strength as parts of the economy reopen and confidence improves, and exports and business investment will be buoyed by rising foreign demand,” said the statement accompanying the decision.

“After a decline in real GDP of 5½ percent in 2020, the Bank projects the economy will grow by 4 percent in 2021, almost 5 percent in 2022, and around 2½ percent in 2023.“

USD/CAD

The Canadian dollar has been on somewhat of a tear over the past two months.

Since the middle of November the loonie had gained 3.3% against the greenback to the open on Wednesday. The US dollar's woes were homegrown as the labor recovery slowed and then in December reversed with Nonfarm payrolls shedding 140,00 position, the first loss since April.

Rising commodity prices in anticipation of a global recovery in the second and third quarters helped the Canadian dollar as well. West Texas Intermediate, the North American crude standard, rose 50% from November 2 to January 14, closing at $53.68.

Canada's largest trade partner is the United States and a rising local dollar puts her exports at a expense disadvantage.

This was noted by Bank of Canada Governor Tiff Macklem who had said that “recent Canadian dollar appreciation is hurting the competitiveness of Canadian exporters in the US market." The policy statement of the December 9 BoC meeting commented that, “A broad based decline in the US exchange rate has contributed to a further appreciation of the Canadian dollar. “

These statements prompted some anticipation that the bank or Governor Macklem in his presentation, might try to talk down the Canadian dollar from its perch, notwithstanding the general ineffectiveness of such rhetoric.

In the event, the BoC simply observed that, “A broad-based decline in the US exchange rate combined with stronger commodity prices have led to a further appreciation of the Canadian dollar,” a statement of fact and nothing else.

As the USD/CAD dropped 47 points in the first five minutes after the release of the BoC statement at 10:00 am (1.2698-1.2651) and 69 points to 1.2629 within 15 minutes, it was clearly the bank's official optimism on the economy and its equanimity on the Canadian dollar that prompted USD/CAD sellers. On the day the USD/CAD opened at 1.2736 and finished at 1.2643.

Governor Macklem's optimism was slightly more measured. “In sum, there is clear reason to be more optimistic about the direction of the economy over the medium term. But we are not there yet. The resurgence in COVID-19 cases weighs heavily on the near-term outlook. And this underlines the ongoing need for extraordinary fiscal and monetary policies,” he said in his prepared comments.

Inflation, the step-child of central bank policy everywhere, was put off into a more positive future. “Excess supply [of gasoline] is expected to weigh on inflation throughout the projection period. As it is absorbed, inflation is expected to return sustainably to the 2 percent target in 2023,” said the BoC statement.

The Bank of Canada's relative good cheer about the economy is a surprising plus for its currency.