While the Bank of Canada may have stopped short of what markets were expecting with its latest interest-rate hike, it remains the most hawkish major central bank in the world, a status that until now has shielded the Canadian dollar against the worst of the rout felt by other currencies.
Citing the potential for the economy to “stall” over the next three quarters, the bank raised its benchmark rate 0.5 percentage points to 3.75 per cent on Wednesday, shy of the 0.75-percentage-point increase many had forecast.
The slower pace still left Canada’s policy lending rate 3.5 percentage points higher this year, the steepest rate-hike cycle among central banks overseeing the 10 most-traded currencies, at least until the U.S. Federal Reserve’s rate announcement next week.
The Bank of Canada’s aggressive rate stance has provided a buffer against the sharp rise of the U.S. dollar. While the Canadian dollar has fallen around 5.5 per cent year-to-date against the greenback, that’s the smallest decline among major currencies. The euro, British pound, Australian dollar and Swedish krona are all down between 10 per cent and 15 per cent over the same period, with Japan’s yen down 21 per cent.
With the bank signalling it is near the end of its tightening campaign, the loonie could be exposed. As Derek Holt, an economist at Bank of Nova Scotia, noted, the bank has “opted for policy divergence from the Fed that will likely weigh upon the Canadian dollar – all else equal – and continue to present upside risk to inflation.”