Canada Cuts Key Rate as Oil Shock Clobbers Inflation Outlook
Comment of the Day

January 21 2015

Commentary by Eoin Treacy

Canada Cuts Key Rate as Oil Shock Clobbers Inflation Outlook

This article by Greg Quinn for Bloomberg may be of interest to subscribers. Here is a section: 

Canada, the largest exporter of oil to the U.S., is loosening monetary policy as a plunge in oil prices raises the risk of deflation globally. The European Central Bank is expected to announce tomorrow it will buy government bonds for the first time. The Bank of Japan has already boosted its asset purchases and the Bank of England said two policy makers had dropped their call for rate increases.

“It’s a shocker,” Sal Guatieri, a senior economist at BMO Capital Markets in Toronto, said in a telephone interview. “It is an aggressive move. It speaks volumes about where the Bank of Canada sees the economy and inflation going.”

The nation’s currency depreciated more than 2 cents against its U.S. counterpart on the rate decision and was quoted at 1.2368 per U.S. dollar at 11:33 a.m. in New York Wednesday. Two- year bond yields plunged 29 basis points to as low as 0.55 percent. Stocks surged 1.9 percent in Toronto.

The price of North American crude oil, Canada’s top export, has plunged 55 percent to $47.36 a barrel since June.

Eoin Treacy's view

As a major commodity exporter the impact of falling commodity prices represents a headwind for a significant portion of the Canadian economy, not least Western provinces. On the other hand lower energy prices and a falling Loonie will be welcomed by the manufacturing sector which has faced stiff headwinds over the last decade. 

The pace of the US Dollar’s advance versus the Loonie has picked up as the oil price fell and has been accelerating for the last week. The rate is closing in on the 2008/09 peak and a clear downward dynamic would be required to question potential for additional upside. 

Taking a step back, It is worth considering that the only times the Loonie has risen to parity have been during commodity bull markets. Depending on how long lower energy prices are sustained for the potential for substantial Loonie strengthening is relatively remote. Additionally, the interest rate differential between Canada and the USA is likely to narrow over the medium-term.   

The TSX Financials Index represents 34.38% of the Index and has been underperforming over the last month. Canada’s banks were among the healthiest in the world during the credit crisis and today’s interest cut acted as a support. The relative health will be influenced by the performance of the housing market as well as the resources sector. The Index will need to hold the October low near 2100 if medium-term potential for additional higher to lateral ranging is to be given the benefit of the doubt. 


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