BoC likely to adopt wait-and-watch approach, says CIBC Research

The Bank of Canada (BoC) is expected to adopt a wait-and-watch approach over the near-term, according to a recent report from CIBC Research. Investors are still attaching a 40 percent probability to further monetary tightening this year. Governor Stephen Poloz is likely to hit the pause button on rate hikes until 2018, when he has a clearer picture of how the economy is reacting to public policy changes.

NAFTA negotiations add another wrinkle to the fold, pushing Governor Poloz even further towards a wait-and-see approach. While the direct impact from a loss of free trade is expected see a manageable 5 percent depreciation in the currency, losing the all-important dispute resolution mechanism could see the loonie react more sharply if the US then targets various Canadian sectors with punitive duties.

But even if NAFTA talks turn out constructive, the recent widening in Canada’s trade deficit and general malaise in non-energy exports, suggest that the economy needs a weak exchange rate to get that sector going again.

Market positioning also points to an upcoming sell-off in CAD. Long positions in the currency have been built up to their highest levels since 2012 on the assumption that the past two rapid-fire rate hikes were indicative of the future path of tightening. Look for a wind down in that positioning to add to the loonie’s underperformance in the coming months.

"As a result, the dollar-Canada is likely to reach 1.27 by year-end, and average 1.29 in 2018. Things could, however, turn out worse for the currency should NAFTA trade talks fall apart," the report added.

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