The Bank of Canada today left its policy rate unchanged at 0.25%, while reiterating that rates will be held at the effective lower bound until 2023 and the QE programme will continue to be in effect at C$4bn a week until the recovery is well underway.
While we didn’t expect much to change from the BoC today given that the meeting comes without a press conference, the continued reference to the strength of the Canadian dollar is meaningful. As we have previously pointed out, relative to other central bank’s the BoC is less explicit with its monitoring of currency markets, but the loonie’s recent rally to two-year highs on the back of broad US dollar weakness may start to test their resolve. Jawboning FX markets is always a delicate task for central bank’s and tends to be embarked upon in speeches or press conferences. In the absence of both today, the BoC opted to merely retain its reference on the loonie’s strength, but this suggests to us that any further CAD strength will likely force verbal action by Deputy Governor Beaudry in tomorrow’s Economic Progress Report or Governor Macklem’s speech to the Greater Vancouver Board of Trade on the 15th.
BoC’s reference to the loonie in today’s rate statement:
A broad-based decline in the US exchange rate has contributed to a further appreciation of the Canadian dollar.
Broad USD weakness has been the dynamic that has resulted in the loonie to carve fresh two-year highs at a time when much of the economy is subject to lockdown provisions, but it doesn’t quite tell the whole story. Many expect the Canadian dollar’s rally in 2021 to exceed other G10 peers based upon expectations of an aggressive global economic recovery, Canada’s high levels of pre-purchased vaccines and supportive fiscal policy. In this light, the loonie’s rally may continue even if the dollar decline starts to stabilise towards the end of the year. Under this scenario, verbal intervention by the BoC is almost an inevitability, but even in the event of sustained USD depreciation, the stronger the loonie becomes the more the BoC’s resolve will be tested. A lot can change in between today’s meeting and Macklem’s final appearance of the year on the 15th, but if the loonie’s rally continues and shows no signs of abating, Macklem may have to resort to tactics last used by Governor Poloz in the early part of 2020.
We suspect that in the interim, the BoC’s purchases of Canadian government bonds are likely to signal the Bank’s current policy stance.
Any ramping up of purchases will signal a willingness by the Governing Council to offset the near-term headwinds to the economic recovery, which would likely result in verbally talking down the loonie at some point. This view is further reinforced by the BoC’s commitment to “keep interest rates low across the yield curve” – another dovish shift that signals lower long-term bond yields as the Bank’s recalibration of its QE programme see’s purchases drift towards longer-dated securities.
Loonie rally unaltered by the BoC’s continued monitoring of FX markets and its dovish twist to flatten the yield curve further
Canadian dollar continues to sit near recent highs against USD and on a trade-weighted basis
Author: Simon Harvey, FX Market Analyst