The Bank of Canada cut interest rates and sent the Canadian dollar plunging. Why did it do that and what can we expect down the road from the BOC?
The team at CIBC explains:
Here is their view, courtesy of eFXnews:
So why cut rates?
The clue is in the Bank’s optimism for a shift in the drivers of growth towards exports, and the analysis it presents showing that exchange-rate sensitive sectors have already been outperforming. Pushing Canadian short rates below where the Fed is likely to be at year-end is having the desired effect on the Canadian dollar. But there’s a long lag in getting the full benefit of the currency move in terms of  waiting for a shift in plant location decisions in Canada’s favour, so monetary policy will have to be easy enough in coming years to allow the recent loonie trading range to become the norm.
Forecast Implications
After its first cut, the Bank of Canada stood pat for nearly a half year, even as economic news looked ugly. A similar degree of patience will likely mean that rates won’t get a serious reconsideration until after October’s election. If, as both we and the Bank expect, economic growth is running a bit above potential by Q4, the case to cut again won’t be there. Two-year bonds are therefore looking a bit rich at this point, as the market puts some odds on a cut to 0.25% that we see as unlikely.
The Canadian dollar, however, could still see weaker levels, not due to a surprise third rate cut in Canada, but driven off an earlier-than-expected Fed hike in September. Look for a run a few cents above 1.30 on dollarCanada as the divergent directions in North American monetary policy play out.
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