BoC may have to act to avoid losing out in a currency war - Rabobank

Jane Foley, Research Analyst at Rabobank, suggests that on the back of last’s Friday releases of abysmal Canadian trade and jobs data the market is less convinced that the BoC will have the nerve to keep rates on hold for the rest of the year.

Key Quotes

“The widening in the June merchandise trade deficit to CAD3.63 bln and an upward revision to the May shortfall, illustrate some of the issues currently confronting Poloz. Even before this release, the outlook for the external sector was looking vulnerable. Statistics Canada reported that of the 35 industries it tracks, only 4 sectors (3.7% of the total) had higher sales abroad in May.

On the back of the poor showing the BoC slashed its forecasts for the contributions of exports to growth to levels well below the long-term average. That said, after a weak Q2 US growth is expected to rebound in the July quarter and this should be a boost to Canada’s overseas trade as should a step up in oil production after the wildfires last quarter. Even so, headwinds persist. Concerns about oversupply remains prevalent in the energy sector and the 13% rise in the value of the CAD vs. the MXN since the start of this year will underpin the sensitivities of the auto sector to potential domestic plant closures. Although the rolling out of larger child benefit payments should boost domestic demand it is also likely to support imports which could limit the degree to which the overall trade deficit can shrink during Q3.

In terms of inflation, most measures of core inflation are close to the 2% level. However, it can be argued that this would be less if it wasn’t for the impact of past exchange depreciation. This boosted consumer energy prices but is expected to dissipate towards the end of this year. While this would provide an argument for the BoC to increase its dovishness, policy setters will be understandably wary about doing anything other than standing pat given the fiscal stimulus that is in the pipeline.

The Bank is forecasting above potential growth in H2 2016 lifted by federal spending in addition to stronger US demand and it is our central view that the BoC will remain on hold. That said, there is talk in the market that with so many other central banks signalling that further monetary easing is on the cards that the BoC may have to act to avoid losing out in a currency war. We are forecasting that USD/CAD will edge up to 1.32 on a 3 mth view, but this assumes the Fed will be positioning itself to hike rates in December. Any delay by the Fed could mean would deny the BoC of a means to attain a weaker currency which could further pressure scope for recovery in Canada’s external sector.”