Bank of Canada Raises Interest Rates

You might have been expecting Patrick to talk about this one (he loves Canada), but he’s a little busy with China right.  So you got me.  The Bank of Canada raised its benchmark interest rate this morning to 4.50%, and the forex market…well the forex market basically yawned.  The USD/CAD pair did retract somewhat from the 30-year low hit yesterday, but the growth did not amount to much.  The loonie is still in a position of strength, and some currency analysts are even talking about parity in the USD/CAD.

Much of the recent growth in the Canadian dollar can be attributed to the international bull market for commodities.  Commodities make up just about half of Canada’s exports.  The price of oil just came down from its 10-month high, but it is still above $70/bbl.  That is especially significant because there is an amazing 85% correlation between the price of oil and the value of the loonie with relation to the greenback.  The prices of copper and gold are also on the ascent, and that is going to provide further support for the loonie.

But the story of the Canadian dollar cannot be explained only by commodity prices.  Wages are up a phenomenal 3.5% this year.  Core inflation, subtracting energy and food prices, was at 2.2% in May, an improvement over the 2.5% level in April, but still above the 2% target set by the central bank.  This allows the bank some leeway to raise interest rates again this year.  The appreciation of the Canadian dollar hurts exporters to some degree (and the world’s ninth-largest economy is still primarily driven by exports), but policy makers in Ottawa believe that a stronger currency might do more good than harm.

Basically, the bank is not going to let USD/CAD approach 1.000.  The central bank will intervene in the forex market before that happens.  But with the pair trading at a little above 1.05 now, do not be surprised to see levels of 1.04 soon.  Some currency traders and analysts have already priced in two more rate hikes by next March.  And they might not be far off, considering the following statement accompanied the interest rate announcement this morning: “some modest further increase in the overnight rate may be required to bring inflation back to target over the medium term.”  For right now, I would bet on the Canadian dollar and be careful when I am on a submarine (dolphins apparently like to watch).