Loonie Flies Higher as Canadian GDP Beats Expectations

Canadian gross domestic product (GDP) surprised to the upside with 0.6% growth in the last quarter of 2014. Canadian fourth-quarter GDP grew by 2.4% compared to a year earlier, beating the 2% expectations and the pace of U.S. GDP in the same time period. USD/CAD was sold after the data hit the wires given the strong Canadian fundamentals.

Despite the optimism, analysts remain mixed on the Bank of Canada’s (BoC) rate decision tomorrow in what may be the BoC’s most heavily scrutinized meeting since the 2008 financial crisis. The commodity-sensitive Canadian economy is reeling in the wake of plummeting oil prices, the nation’s biggest export.

The positive GDP figures have dampened expectations about a second rate cut by BoC Governor Stephen Poloz. Although he abandoned the forward guidance policy and surprised the market with a January cut, he has divided analysts who have already forecast a rate cut regardless of Canuck fourth-quarter GDP. The Canadian benchmark interest rate stands at 0.75%.

The Reserve Bank of Australia’s unexpected decision to stand pat on its cash rate, and the strong Canadian GDP data, drove the loonie, as the Canadian $1 coin is known, higher versus the greenback as the probability of an interest rate cut by the BoC diminished. USD/CAD dropped from 1.2520 to 1.2440 after Statistics Canada released the figures. The currency pair is entering the final stretch of the trading day at 1.2480.

Poloz on the Hot Seat

Poloz explained the January cut as pre-emptive given the macro headwinds that the Canadian economy is facing. Lower energy prices have hit the oil-producing province of Alberta, the country’s main engine of growth in the post-credit crisis years. There are low expectations of a rate cut this week, but the market is pricing more cuts coming this year.

The January rate cut gave the central bank time to watch the effects of the move and consider its next intervention. The CAD could head higher if a no rate cut decision is published. The strong GDP reading further validates this line of thinking ahead of tomorrow’s announcement.

Contrarians have pointed out that the negative effects of the lower oil prices have not been fully taken into account for fourth-quarter GDP. The Canadian economy will continue to slow down and will not have the positive effect of higher inventories to offset falling energy prices. While there is some disagreement on the timing, the majority of analysts see a rate cut sooner rather than later in an attempt to boost the stagnating Canadian economy.