Better times ahead for loonie
U.S. trade policy and the timing of Donald Trump’s long-awaited tax reforms are helping to form a hazy outlook for Canada, but the domestic economy and, in turn, the loonie should be better equipped to deal with any negative developments in 2018 after putting a solid year of growth under their belt.
Regardless, the Bank of Canada is taking a more cautious stance on future monetary policy tightening following two interest rate hikes within a three-month span.
“The Canadian dollar could be under some pressure early in 2018 as the BoC delays its rate normalization process in recognition of the uncertainties … but some recovery is anticipated once the BoC begins to match the pace of Fed tightening,” said Mark Chandler, head of Canadian rates strategy at RBC Capital Markets.
On the plus side, WTI oil prices are also forecast to average US$58 per barrel in 2018, providing some much-needed respite for the energy sector and the Canadian economy as a whole.
But the first part of the year will also see new mortgage/housing regulations and minimum wage legislation in Ontario, as well as a modestly positive impact on U.S. GDP due to tax reform and the wild card that is NAFTA re-negotiations.
“However, even with these challenges from our largest trading partner (roughly 75 per cent of Canada’s merchandise exports were destined for the U.S. on average in 2017), one thing we learned this year was that the domestic economy does have the wherewithal to ‘go it alone’ for a period — even without a resolution on trade or a fiscal boost south of the border,” Chandler said.
Following Friday’s GDP report for October, it appears fourthquarter growth will come in below the BoC’s expectation of 2.5 per cent (annualized). Given the central bank’s reliance on economic data, a rate hike in January now looks less likely.
Governor Stephen Poloz probably wants to be sure that October’s weakness was simply a blip before making another hike. The stalemate in NAFTA talks, large minimum wage increases and new mortgage rules that begin in January only cloud the outlook further.
“Those are all good reasons for the Bank of Canada to stand pat until at least April,” economists at CIBC World Markets said in a report. April is also when there will likely be more clarity on whether conditions are ripe for the U.S. Federal Reserve to resume tightening.
CIBC is forecasting the Canadian dollar will fall to about 75 cents U.S. in Q1 as NAFTA negotiations reach a climax. The loonie should find some stability after that, barring an all-out trade war with the U.S.
“Even if growth remains just firm enough to justify a quarter-point BoC move in Q2, the delay versus market expectations will directly weigh on the loonie,’ CIBC said. “So too would any fears that, if Canada loses its NAFTA dispute resolution access, it would be more exposed to U.S. protectionist measures.”
In the meantime, the strength in oil prices has served to offset softer rate hike expectations. But there is concern that crude is approaching levels that would incentivize more output from countries not in the OPEC cartel, potentially putting a cap on further upside.