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Bank of Canada Holds Interest Rate Steady, Changes Tone in Monetary Policy Statement

As expected, the Bank of Canada held interest rates steady and gave no indication whether it is poised to ease or hike interest rates in its statement following the Monetary Policy Committee meeting today. However, the statement marked a clear change in stance from what has been witnessed over the last few months. The BoC recently underplayed growth, focused on slack in the labour market, and underutilisation of capacity, reiterating the difference in economic cycles between the US & Canada.

In the April statement, there was a reference to the US being close to full employment in contrast to Canada where “material slack” remained. This reference to the US labor market was totally dropped in the statement released today. The BoC Governor and other officials have mentioned this difference in US & Canadian labour markets several times in recent months. The dropping of this comparison between the US and Canada marks a clear departure from the BoC’s cautious outlook.

The statement today contained a reference to the impact on the Canadian economy due to a fall in oil prices over the last two years. The BoC statement stated that the Canadian economy’s adjustment to lower oil prices is largely complete and recent economic data has been encouraging, including business investment. BoC statement also highlighted continued robust consumer spending due to an improving labor market. These statements are a clear upgrade of economic outlook and a clear departure from the cautious outlook for economic growth seen in the earlier statement from BoC this year. While BoC did not go to the extent of sounding overtly optimistic about growth, it has refrained from using the phrase “growth was temporarily boosted by…” as seen in April. The interpretation that one can draw from this is that the BoC is far more certain about growth going forward than it was in April.

With reference to inflation, the tone continued to be cautious regarding lower food prices pushing inflation lower “temporarily.” This means that the BoC expects Inflation to move back higher in the coming months.

The forward-looking growth expectations also received a boost. In April, the statement mentioned that growth during the rest of the year is expected to moderate. This was discreetly upgraded by use of the word “some.” In this statement, the BoC expects “some moderation” in the second quarter, which again indicates a slight upgrade of economic assessment.

The BoC added a new sentence vis-à-vis monetary policy – “current degree of monetary stimulus is appropriate at present.”  The reference to the much talked about “housing market” was fleeting with the statement that, “recent policy measures have yet to have a substantial cooling effect on housing markets.”

Overall the statement marks a clear change in stance with respect to acknowledging better than expected economic data in the past few months. The earlier stance had been to downplay this and highlight the risks via the “significant uncertainties weighing on the outlook.” This statement rules out any probability of increasing monetary stimulus in the near future, which was mentioned in January this year. At the same time, the probability of an interest rate hike by the BoC is quite remote and futures prices indicate only about 20% probability of a rate hike in 2017. 

Market Reaction

The Canadian Dollar was taken by surprise by the change in tone of the BoC’s statement and immediately firmed up. These gains stretched further after the release of Federal Reserve FOMC meeting minutes, which showed that the Fed would reduce its balance sheet at a gradual pace.  Overall the USD/CAD gained over 100 points throughout the day, making a strong comeback after the steep fall witnessed over the last few weeks largely due to tensions on the trade front with the US. It needs to be kept in mind that speculative short positions on the Canadian Dollar hit a record high last week at 98k contacts. If speculators are forced to cut these positons we could expect the Canadian Dollar to rebound all the way down to 1.3000 levels.

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