Canadian Dollar Rate Cut

The Canadian dollar strengthened against the US Dollar over the course of the week, despite a rate cut by the Bank of Canada, as interest rate differentials continue to benefit the Loonie. Indeed, the possible implications of a 25bp rate reduction to 4.00 percent - lowest level since April of 2006 - by the Canadian central bank was offset by an unexpected emergency 75bp rate cut by the Federal Reserve.

Nevertheless, there is potential for Canadian dollar weakness in the future judging by the policy statement that accompanied the BOC rate announcement. While the outlook for growth was still relatively upbeat, as the bank said it expected domestic demand to “remain strong,” the group lowered its outlook for growth in 2008, saying it was “significantly weaker” than its October projection given the negative impact of the rapid appreciation of the Canadian currency on export sector activity.

On the inflation front, the BOC forecasted core CPI to fall below 1.5 percent by mid-year - which appears entirely possible after the bank’s inflation measure surprisingly dipped to 1.5 percent in December – and with the BOC’s inflation target still well above at 2 percent – the statement said that further “stimulus” would likely be needed in the “near term.”

Looking ahead to this month, the fate of USD/CAD will likely depend more upon the status of the greenback given the major event risk looming in the US. Meanwhile, Canadian economic data may not prove to be extremely market-moving though they could contribute to Loonie weakness. The orders component of the Business Conditions index is anticipated to drop to a one year low of -6.5, as the combination of an economic slowdown in the US and a stronger Canadian currency prove to be a major hindrance for manufacturers.

Meanwhile, November GDP figures are forecasted to reflect tepid growth, though the Q4 GDP reports (which will not be released until early March) will be a far better gauge of the status of the Canadian economy. Regarding USD/CAD, according to Technical Strategist Jamie Saettele’s Daily Technical Report on Friday, “potential resistance is at 1.0128,” and a failure to break above this level may find the pair falling back below 1.0012. Nevertheless, traders should keep an eye on broad US Dollar trends, as they may dictate the next move for USD/CAD.