Normalization over trade war (risk)

The Canadian economy is in good shape. And economic data won’t contradict the facts. Governor of the Bank of Canada (BoC), Stephen Poloz, is therefore in a difficult situation. With both favorable economic data on one side and potential trade war with its largest commercial partner on the other, economic policy lies in the grey zone.

Indeed, with an inflation rate above BoC’s 2% target, wage growth largely exceeding consumer price indexes, unemployment rate at one-decade low and, most importantly, an economic expansion above the 2.20% projections from the Canadian monetary authority, the odds would most certainly support further monetary policy tightening.

However from a risk management approach, uncertainties regarding further trade sanctions from the US remain. The North American Free Trade Agreement (NAFTA) negotiations initiated on 16. August 2017 keep dragging on amid current tariffs on lumber, steel, aluminum, including forthcoming auto and automotive parts taxes.

Therefore, under such circumstances and despite ongoing geopolitical tensions, Stephen Poloz must necessarily take the responsibility to go for a rate increase during today’s monetary policy meeting in order not to lie behind the curve. Since Canadian interest rates remain among the lowest between the largest central banks of the world and the loonie continues to weaken, we see no further reason for current extreme accommodative financing conditions to sustain. Given at 1.25%, the BoC policy interest rate will be increasing by a quarter percent to 1.50%.

Trading along 1.3140, USD/CAD consistently strengthened since the beginning of the year (year-to-date: +4.70%). We would therefore expect the pair to head along 1.31 right after the Bank policy announcements.