In recent weeks, the Canadian dollar has been under considerable pressure, weakening past the 1.4 per USD mark and inching closer to its mid-2020 low of 1.41, which was last observed on November 15th.
This downturn comes as investors closely digest GDP data that has significant implications for monetary policy in Canada.
The economic landscape, marked by fluctuating growth rates and geopolitical tensions, is leading many to question the future trajectory of the Canadian economy and its currency.
GDP Growth and Implications
The Canadian economy increased at an annualized rate of 1% in the third quarter of 2024.
This statistic contrasts sharply with the upwardly revised growth rate of 2.2% for the second quarter, which first boosted market confidence.
While the current growth statistic is consistent with market expectations, it falls short of the Bank of Canada’s 1.5% projection.
This dismal performance raises concerns about the economic momentum’s long-term viability and the efficacy of present monetary policies.
The GDP data can be interpreted as a signal that the Canadian economy may not be as robust as hoped, leading to speculation about a potential cut in interest rates.
The Bank of Canada is expected to implement a nominal 25 basis points (bps) rate cut in December, a move designed to stimulate economic activity amid lacklustre growth.
However, with inflation rates showing unexpected strength, the central bank may face a difficult balancing act between stimulating the economy and keeping inflation in check.
Inflation’s Role in Monetary Policy
Inflation has emerged as a crucial factor influencing the Bank of Canada’s monetary policy decisions.
In a surprising turn of events, the trimmed mean core inflation rate—the central bank’s preferred measure—jumped to 2.6% in October, rising from 2.4% in September.
This uptick in inflation could complicate the central bank’s plans to ease monetary policy.
Rising inflation, particularly amid stagnant GDP growth, creates a unique scenario where the bank must tread carefully.
Cutting rates in the face of inflation could lead to further depreciation of the Canadian dollar, presenting potential difficulties for Canadian importers and consumers.
Geopolitical Tensions Impacting the Economy
Another important element contributing to the Canadian dollar’s drop is the geopolitical scene, notably the ongoing trade disputes and tariff threats issued by US President-elect Donald Trump.
Trump recently confirmed his desire to put a 25% tariff on Canadian and Mexican imports, as well as a 10% rise on Chinese goods.
These threats are especially concerning for Canada, considering its economic reliance on US demand for energy products and autos.
The predicted tariffs might limit exports, putting an additional burden on Canada’s already shaky economy.
Investor mood is dampened by these looming geopolitical dangers, increasing the challenges provided by domestic economic indicators.
The anticipation of higher tariffs may lead to lower consumption and investment, further impeding economic recovery efforts.
Outlook: Prospects for the Canadian dollar
As we reach the end of 2024, the mix of slowing GDP growth, inflationary pressures, and geopolitical uncertainty creates serious concerns about the Canadian dollar’s future performance.
The anticipated interest rate drop may bring some short-term respite to the economy, but if inflation continues to climb, the Bank of Canada will face a difficult situation.
The Canadian dollar’s trajectory will be primarily determined by how the central bank navigates these issues while also responding to external pressures from trade partnerships, particularly those with the United States.
Investors and economists will closely monitor impending economic data releases and changes in central bank policy since these will act as indicators of the currency’s future movements.
The ripple effects
The current state of the Canadian dollar demonstrates the intricate relationship between GDP growth and currency valuation.
As Canada grapples with economic challenges and external pressures, it becomes increasingly vital for policymakers to find solutions that balance growth, inflation, and stability.
The coming months will undoubtedly be pivotal in shaping the future of the Canadian dollar and the broader economy.