The Bank of Canada cut this week, facing potential economic headwinds from trade policy uncertainty. While growth has improved over the last two quarters, the BoC noted that it expected the trade conflict with the US to weigh on economic activity, while also increasing prices and inflation.
This highlights a potentially difficult tradeoff for some G10 central banks—how they will respond to the mixed and sometimes opposing impacts of tariffs on inflation and growth.
Though the effects of the latest tariff policy have yet to be clearly realized in the hard data, the BoC may have revealed a slight preference to cushion the negative growth impacts. The statement offered no forward guidance on the path of policy from here. Though the Bank noted that “monetary policy cannot offset the impacts of a trade war,” we read this as only a slightly hawkish signal and more as the BoC putting pressure on fiscal authorities to address the headwinds to growth.
Our economists maintained their forecast for two more 25bp cuts from the BoC this year, and we see this as supporting our more bearish view on the currency. Despite the market pricing in diminished US exceptionalism in the form of a weaker USD, we think CAD is the least likely G10 currency to benefit. CAD tends to be vulnerable to weaker US growth pricing, as Canadian and US growth are closely linked. In fact, CAD saw the least upside versus the Dollar last week out of the G10. If US growth sentiment continues to worsen, we think CAD would likely remain an underperformer versus the rest of G10.
Overall, we continue to think risks lean towards sustained weakness in CAD. We have preferred to express this versus MXN, but also see opportunity in long EUR/CAD for investors looking to take advantage of greater European optimism with more insulation from stronger USD moves.
