Amidst signs of rising inflationary pressures and a strong recovery in underlying economic activity, Canada joined the early recovery club early on. With strong fundamentals of its own and the expectations of a spillover from its outperforming neighbour, the United States, the Bank/Banque signalled its intent to normalise policy ahead of many of its G10 peers. Canada’s exposure to the commodity market, one of the first movers on vaccine success, also provided a credible route out of crisis era policy. Since then, inflation has continued its path higher not only within Canada but globally and the facade of transitory or temporary inflation is wearing ever thinner. Strong labour market data beating estimates earlier in the week were also contributing for calls of normalisation in the Canadian fixed income market. Moving into yesterday’s monetary policy decision, investors were net long of CAD to a degree that made it one of the most convicted calls within the FX space. This context led to volatile conditions when the decision was released yesterday afternoon.
Initial headlines appeared to show the central bank was moving in line with the market’s expectations, maintaining and adding conviction to its pursuit of tighter monetary policy. Bond purchases, part of the QE program were reduced by a billion Canadian dollars per week. However, the central bank stopped short of adjusting its forward guidance around rate hikes maintaining the deliberately ambiguous advice of ‘some time’ within the latter half of 2022. They also noted that excess supply within the economy created by the coronavirus pandemic would not be outpaced by demand until next year. This signalled that, from the bank’s perspective, policy action won’t be necessary to stymie demand until such time as a tight economy creates forces that threaten durable inflationary pressure.
Despite a short term spike in the value of the Canadian Dollar during the release, likely driven by headlines of a rapid decrease in the rate of asset purchases, the ultimate move was towards a weaker CAD across the board. With inflationary pressures continuing to build across the globe, Canada may be forced to amend its forward guidance and phase out new asset purchases completely by the end of this year, and begin raising rates earlier in 2022. If the data points to sustained inflation over the coming months, and the central bank does follow this route, it’s likely a stronger Loonie will prevail.
Discussion and Analysis by Charles Porter