Loonie Tumbles After Dovish Bank of Canada Hikes By 25bps, Warns Of NAFTA Uncertainty

As expected by a broad majority of economists, the Bank of Canada just hiked its overnight rate by 25bps to 1.25%, the first hike by a G-7 central bank in 2018.

In raising the rate, the BoC said that "recent data have been strong, inflation is close to target, and the economy is operating roughly at capacity" however in a dovish twist the BOC added that "as uncertainty about the future of NAFTA is weighing increasingly on the outlook, the Bank has incorporated into its projection additional negative judgement on business investment and trade.

From the bank's forecasts:

In Canada, real GDP growth is expected to slow to 2.2 per cent in 2018 and 1.6 per cent in 2019, following an estimated 3.0 per cent in 2017. Growth is expected to remain above potential through the first quarter of 2018 and then slow to a rate close to potential for the rest of the projection horizon.

The central bank also sees the following key indicators:

CPI Inflation Y/Y:

  • 2017 Q2:1.3%, last 1.3%
  • 2017 Q3:1.4%, last 1.4%
  • 2017 Q4:1.8%, last 1.4%
  • 2018 Q1:1.7%

Real GDP Y/Y:

  • 2017 Q2:3.6%, last 3.7%
  • 2017 Q3:3.0%, last 3.1%
  • 2017 Q4:3.0%, last 3.1%
  • 2018 Q1:2.7%


However, what appears to have spooked traders is the general dovish context of the statement:

Looking forward, consumption and residential investment are expected to contribute less to growth, given higher interest rates and new mortgage guidelines, while business investment and exports are expected to contribute more. The Bank’s outlook takes into account a small benefit to Canada’s economy from stronger US demand arising from recent tax changes. However, as uncertainty about the future of NAFTA is weighing increasingly on the outlook, the Bank has incorporated into its projection additional negative judgement on business investment and trade.

As a result of the unexpected dovish addition, while the loonie initially kneejerked higher, it has since given up all gains and is now near the lows of the day.

asd

The BOC also noted that "while the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target." 

In conclusion, the "Governing Council will remain cautious in considering future policy adjustments, guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation."

And as Citi's FX desk notes, in nine mentions of NAFTA in the MPR, "this one sounded particularly cautious: However, the uncertainty associated with the NAFTA renegotiations has increased, weighing further on the outlook for investment and exports."

The result: a dovish hike.

That said, before traders chase the move, remember that there is a press conference coming up at 11:15 EDT and Poloz’s second appearance at 16:00 EDT in an interview with BNN. It is also worth remembering that there are not a lot of topside levels that could push USDCAD higher here: the 100d MA and January 11 high is the first level of resistance of note - and that is not until 1.2588-90.

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