The Canadian dollar jumped in the immediate minutes the Bank of Canada (BOC) released its interest rate decision. As expected the bank made its first rate hike since December last year. It moved the base lending rate to 1.50% from the previously-released 1.25%. It was the fourth hike since last summer. This rate – also known as the overnight rate – is an interest rate that banks pay for short-term loans. As the rates rise, so does the cost of lending. In fact, three of the largest Canadian banks have already started raising mortgage rates with the Royal Bank of Canada hiking by 3.7% starting today.
As shown below, the USD/CAD pair fell sharply before recovering.
In recent days, the Canadian economy has received a major support from the economic data. On Friday, the country released better-than-expected jobs numbers, which came after a dip a month earlier. On Monday, the country released better-than-expected housing numbers and in recent months, the country’s inflation has remained on the targeted 2.0% rate. This was an early indication that the country would move forward to hike rates during this meeting. The chart below shows how the Bank of Canada has adopted to changing economic situations.
In the monetary policy statement released yesterday, the officials said that the country was scheduled to see a 2.0% GDP growth in 2018. It will accelerate to 2.2% in 2019 and then slow in 2020 at 1.9%. This was in line with what the officials have said in the previous statements.
The biggest concern of the officials was on the tariffs that the US has initiated on the country’s steel and aluminium sector. The statement said that the country’s imports and exports were likely to fall as the prices increase. Specifically, they said that:
‘And then there are countermeasures. Canada has imposed a 25 per cent tariff on steel imported from the United States. This would seem to level the playing field, but many of the same complexities enter the analysis. All things considered, our analysis suggests that Canadian exports would fall, as would Canadian imports. Prices would rise at a time when the economy is already operating at capacity, so inflation would rise at least temporarily, but the effect could persist. Consumers would have less purchasing power, so demand would slow. Meanwhile, the potential of the economy would be eroded as companies invest less and become less competitive. So, the economy would see shocks to both demand and supply, resulting in two-sided risks to future inflation.’
This is an important statement that summarizes the dilemma policy officials are going through as a trade war starts. This is more important for Canada, which is America’s closest trading partner. Every day, goods and services worth billions of dollars cross the Canada-US border. It has also been confounded by the ongoing tussle over NAFTA. To a large part, NAFTA has been a good deal for the three countries: US, Canada, and Mexico. Mexico, the poorest of the three has been able to boost its economy by becoming a manufacturing hub while the US residents have been able to buy quality American products at a fraction of the cost.
These concerns are the ones that made the Canadian dollar to fall against the US dollar as traders expect the BOC to remain cautious about the impacts of a trade war.