CAD could outperform on the back of monetary policy divergence - ING

As mostly expected, the Bank of Canada left interest rates unchanged today. According to Viraj Patel, FX Strategist at ING, the Canadian dollar could outperform among commodity currencies on the back of monetary policy divergence.

Key Quotes:

“Holding rates at 0.5% may come as a slight surprise given the current risks to Canada’s economy. The UK is Canada’s 3rd largest export destination, so the Brexit vote will only add to the already weak Canadian trade data. However, this uncertainty may have counterintuitively nudged the BoC towards holding rates – business confidence is vital in an environment of uncertainty, and a rate cut could have been regarded as a signal that faith in the economy is fading. Sluggish oil prices also held an argument for a rate cut. A push for divergence away from resource sector reliance has been present in Canada. The decision to keep rates at 0.5% could suggest that such diversification has lowered the vulnerability to low commodity prices.”

“The BoC’s reluctantly neutral bias is unlikely to have much of a lasting market impact; USD/CAD dipped below the 1.3000 handle shortly after the policy announcement, understandably as speculative markets were likely short CAD ahead of the meeting given the tail risk of a dovish BoC surprise. While the near-term economic outlook continues to weaken, the BoC’s steady tone today confirms that the bar for another rate cut remains extremely high.”

“We won’t know until later this year whether the central bank’s optimistic forecast for 3Q16 GDP growth (+3.5% QoQ) will materialise; however, until then, we suspect that CAD could outperform its commodity-FX peers on the back of diverging monetary prospects. In particular, we like to sell AUD/CAD in the near-term (target 97.00), with both 2Q16 Australian CPI data (27 Jul) and the Aug RBA meeting likely to be AUD negative events.”

“The BoC’s export-led growth strategy continues to warrant a weak CAD; we continue to see USD/CAD 1.25 as the near-term lower bound threshold and suspect that any material move below here could be met with more forceful action from the central bank (ie, aggressive jawboning or even a rate cut).”