Loonie Bears caught off guard by Poloz’ Hawkish speech

The Bank of Canada’s governor Stephen Poloz surprised the market on Thursday by issuing an upbeat statement on the economy. A week before Poloz had issued a dovish interest rate statement. The unexpected U-turn came up when Poloz delivered a speech to an audience at the Canadian Club, Toronto.

The speech, titled “Three Things Keeping Me Awake at Night” , reflected Poloz’ optimistic economic outlook for 2018. Poloz told the audience that he was happy with the way things developed in 2017 and expects further economic improvement in 2018.

Poloz told

“The economy has made tremendous progress over the past year, and it is close to reaching its full potential. We are very encouraged by this, and we are growing increasingly confident that the economy will need less monetary stimulus over time”.

According to Lee Hardman, a currency strategist at MUFG, the statement made by Poloz has increased the odds of another rate hike early next year. Hardman believes that the Bank of Canada will announce the rate hike in the spring. He also expects the statement to provide good support to the loonie in the near-term.

It can be remembered that the Bank of Canada raised the benchmark interest rates by 50 basis points twice this year, once in July and September, taking the overall interest rate to 1%. Analysts were expecting another rate hike in December or January. However, the recent poor economic data and a series of bearish comments from Poloz dampened the rate hike expectations. That sparked a Canadian dollar sell off in November. Now, the overwhelmingly positive statement has turned the sentiment bullish towards the Canadian dollar.

There is yet another factor which supports a rally in the Canadian dollar. The Overnight Index Swaps prices indicate a cash rate of 1.25% in April 2018. Likewise, Overnight Index Swaps point to a cash rate of 1.48% in September 2018.

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However, Poloz, a seasoned economist, remained neutral by saying

“the economy was approaching its sweet spot where demand creates its own supply”.

That means, the strong demand is likely to continue without generating inflationary pressure. So, theoretically it means the Bank of Canada would remain patient and raise rates gradually.

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