On Wednesday July 12, the Bank of Canada hiked interest rates up from 0.5% to 0.75%.
The day before, the Canadian dollar was trading at an average of about 77.40 US cents. The next day, following the Bank’s announcement, the CAD rose to 78.70 US cents. Why?
Although the Bank of Canada’s announcement was widely anticipated, Bank of Canada governor Stephen Poloz’s high level of confidence came as a surprise. Mr. Poloz described the rise as ‘a symptom’ of a growing economy that is expected to be back in full swing by the end of the year. He said that the Canadian economy has ‘turned the corner’.
Adjustment to lower oil prices
Oil prices, which began to tumble in 2014, played a major role in the Canadian dollar’s reduced value. Now the Bank of Canada believes that since the ‘adjustment to lower oil prices is largely complete, both the goods and services sectors are expanding.’ That’s another reason for the loonie’s rebound.
Continuing growth and moderate inflation
After the announcement the bank’s governing council released a statement explaining that ‘growth is broadening across industries and regions and is therefore becoming more sustainable.’ Canada enjoyed annualized growth of 3.5% in the first quarter of 2017. Although the Bank of Canada expects this strong growth to fade, the outlook for the year still looks very positive. They recently revised their 2017 growth outlook from 2.6% to 2.8%. Canada’s inflation rate is projected to average just under 2% per year over the next two years, possibly increasing to 2.1% by 2019.
The U.S. Federal Reserve
The Bank of Canada’s American counterpart, the Federal Reserve, also contributed to the Canadian dollar’s rise. Fed Chair Janet Yellen hinted on July 12 that they may not raise rates as quickly as some have predicted. Higher rates lead to a stronger currency, so Ms. Yellen’s comments may have encouraged greater investment in CAD.
In a further statement accompanying the rate decision, the Bank of Canada observed that the Canadian economy has been robust, fuelled by household spending.
‘As a result, a significant amount of economic slack has been absorbed,’ the bank said, adding that the remaining slack is expected to be gone around the end of this year, which is earlier than the bank anticipated in its April Monetary Policy Report.
Dave Ritcey, The Ritcey Team, Scotia Wealth Management