Bank of Canada will hold its policy meeting on Wednesday and is widely anticipated to raise interest rates for the first time in seven years, with the move expected to drive interest rates and the Canadian dollar higher.
If the central bank does lift benchmark interest rates, it will become only the second major central bank after the Federal Reserve to tighten the monetary policy.
Meanwhile the European Central Bank is still maintaining a dovish posture, though a recent account of discussions from its meeting policy meetings last month and comments from ECB President Mario Draghi have been read by market participants as hinting at policy makers considering the reduction of accommodative policies in the near term.
Against that backdrop, the BOC may be pivoting toward its own measure of tightening, should it move to normalize its own interest-rate policy.
Such thinking and talk has helped to send the Canadian dollar rallying in the wake of comments from senior deputy governor of the Bank of Canada, Caroline Wilkins, back in mid June. The change in tone was later ratified by further comments from Gov. Stephen Poloz, who said rate cuts in 2015 have done their job.
The economic picture also has brightened in Canada.
On Friday, the Canadian dollar
rallied on Friday after better-than-expected jobs gains in June. On Tuesday, the loonie boasts a 4.4% climb against the buck over the past four weeks, with greenback buying C$1.2922, despite a slight pullback Tuesday.
There are still big headwinds to the loonie, and Canada, more broadly. Those include, stubbornly low crude-oil prices and negotiations around the North American Free Trade Agreement.
West Texas Intermediate crude-oil futures trading on the New York Mercantile Exchange
—the U.S. benchmark—are down 16%, so far in 2017 and entered a bear-market, defined as a decline from a recent peak of at least 20%, late in June. Meanwhile, Brent crude
the international benchmark, has seen an equally severe drop over the same period.
While higher interest rates are generally supportive for the loonie, it is still dependent on the vagaries of the oil industry. Canada was the seventh largest producer of crude oil, with some 3.6 million barrels of oil a day in 2016, according to date from the U.S. Energy Information Administration, including crude byproducts. The country also is among the top 10 biggest exporters of crude.
“While the most recent price action has been more supportive for the Canadian dollar, we still see oil prices as a reason to be a bit more bearish in the longer term,” said analyst at Bank of America Merrill Lynch in a report from July 4.
Analysts at Bank of America view the loonie as somewhat overvalued and still expect it to weaken to C$1.35 by the end of the year. Their previous forecast was C$1.39.
Stubbornly sluggish inflation is another factor that analysts at B. of A. find at odds with what could be a hawkish turn by the Bank of Canada.
“The Bank of Canada, who watches their 2% inflation target closely, is missing their target to the downside across the board. Not only has headline inflation fallen toward 1%, but core inflation measures are now also closer to 1% as well,” said the note.
But the tendency to ignore low inflation has been observed in other central banks. The Fed raised interest rates in June, brushing aside low inflation as “transitory.”
So a hawkish step by the Bank of Canada shouldn’t be a surprise, in that context.
“The BOC was not forecast to hike rates until 2018 as there are still major question marks with oil prices and the Nafta negotiations in the fall, but the pace of growth in the Canadian economy is giving the central bank the confidence to make a move sooner rather than later and keep up with the Federal Reserve,” said Alfonso Esparza, senior currency analyst at OANDA in emailed notes.