BoC reaction function is crucial for FX – ING

The balance of growth and inflationary effects from US tariffs is of huge importance for FX, as this will determine the Bank of Canada’s policy reaction and potentially widen the USD-CAD rate gap even further, ING’s FX analysts Francesco Pesole and James Knightley note.

BoC cuts exacerbate the depreciation of CAD

“With 75% of Canada’s exports going to the US – equating to 20% of Canada’s entire GDP – the risk of an outright recession is high. The BoC has already cut the overnight rate 200bp and our call for two additional 25bp rate cuts now is subject to significant risk.”

“The BoC will be concerned about the inflationary threat provided by Canada’s own tariffs, but given the headwinds to Canadian growth and jobs that Trump’s actions pose we suggest the balance of probabilities is skewed towards the BoC offering more support via looser monetary policy.”

“That could result in a ‘snowball effect’ for CAD, where BoC cuts exacerbate the depreciation already caused by tariff-related risk premium. We cannot exclude the possibility of the Trump administration then accusing Canada of ‘artificially’ depreciating CAD via lower rates to mitigate the tariff impact.”