CAD Tumbles After BoC Expresses Reluctance to Raise Rates

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For the fifth consecutive monetary policy meeting, the Bank of Canada left interest rates unchanged at 1 percent. Even though the central bank grew more optimistic about the outlook for Canada, even going so far as to raise its 2011 GDP forecast to 2.9 from 2.4 percent, the strong Canadian dollar has made them reluctant to raise interest rates. With one Canadian dollar worth more than one U.S. dollar, the central bank's greatest concern is that exports to the U.S. will continue to suffer. This morning, Canada reported a smaller trade surplus and a 4.9 percent decline in exports. Since the middle of 2010, the Canadian dollar has been in a relentless rally that has taken it 3.5 year highs against the U.S. dollar. As a result of the currency's persistent strength, the BoC is worried about "greater headwinds." Going into the BoC meeting, currency traders were looking for hawkish comments from the central bank and even though they delivered, their clear reluctance to raise interest rates has sent the CAD tumbling.

Outside of their concern about CAD strength, the comments from the Bank of Canada were mostly positive. The BoC believes that the global recovery has improved and there are signs of solidifying U.S. economic growth. They also believe that the Canadian economy will reach potential 6 months earlier than previously anticipated which is a very positive assessment for Canada. Although they repeated that further rate increases need to be carefully considered, they also said the economy now has "material excess supply" which is a step towards tighter monetary policy. We still believe the BoC is on track to raise interest rates in Q3 and that USDCAD will have a very tough time recapturing parity this year.

Although this morning's economic reports showed a slowdown in Canadian trade activity in the month of February, overall the Canadian economy is still performing well thanks to higher commodity prices and continued global recovery. The country's trade surplus narrowed to C$33 million from C$382 million. The 4.9 percent decline in exports which was caused mostly by weaker demand for autos was expected given the strength of the Canadian dollar but the 4 percent decline in imports was surprising and due largely to softer energy and auto demand. The housing market on the other hand is showing new signs of life with the price of new homes rising 0.4 percent in February.

Meanwhile the U.S. reported a narrower trade deficit but a downward revision to the January number and a larger print in February made the overall report dollar bearish. Exports rose 2.7 percent while imports increased by 5.2 percent, a sign of continued economic recovery. Although higher crude prices contributed to the rise in imports, the pace of growth slowed 50 percent from the previous month. The most substantial gains were seen in imports of semiconductors, computers, telecom equipment, cars and apparel which suggests that an improvement in core demand. Imports from China continued to grow while exports slowed. Higher food and energy costs also drove import prices up 2.7 percent.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Forex and Currencies

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