© Alex Bellefleur
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From the historical experience, when the BoC cuts interest rates, it does not tend to do it just once. Over the past 20 years, there has not been one time when the Bank of Canada cut rates just once by 25 bps. Therefore, this would suggest that we are headed somewhere very close to the zero lower bound. The BoC has little traditional monetary policy ammunition left. Hence, the cut in Canada's energy exports income will have a significant impact and represents a clear negative shock to the economy. I believe this drop in incomes will then probably hit housing, an asset that has been appreciating almost non-stop for 15 years and, as a result, is considered by many households to be fail-safe. Hence, this supports further rate cuts down the road, whereas there is a unique opportunity for the BoC to diverge from the Federal Reserve and its policy normalization.
On Wednesday, governor Poloz said borrowing costs have eased considerably in response to the bank's rate cut in January and global financial developments. One result is a lower Canadian Dollar on exchange markets; however, do you believe that these conditions will soften the negative effect of the oil price shock?
I do not fully agree, since on a rolling 12-month basis, the value of Canada's trade balance on crude oil is around 4% of GDP. This is essentially an income transfer from the rest of the world (or, in truth, from US consumers) to Canada. I believe if the value of these transfers were to be cut in half, this would represent about 2% of GDP, which is obviously a big shock. Moreover, there is also a balance sheet effect. If the oil price shock translates to weaker housing, this will impact household balance sheets. Summing up, I would like to mention that one rate cut will not be enough to offset that.
What will be the headwinds for the Loonie in the short and long term?
To my mind, the key determinants of the Canadian Dollar behavior will include productivity problem versus the US, a competitiveness issue for non-energy industries.Moreover, significant leverage in the household sector will have a serious impact, and a stretched housing market is a quite an important element. Also, I would like to mention limited policy flexibility on the monetary and fiscal sides, which could influence the Loonie.
What are your forecasts for USD/CAD and EUR/CAD for the end of Q1 and in the long term?
I expect to see the USD/CAD moving higher in the future. Talking about the forecasts, we anticipate the USD/CAD at 1.25-1.27 levels by the end of Q1 of this year. As concerns the long term perspective, we see the pair trading at 1.40-1.45 in 18 months from now. I would like to mention that I do not see significant moves in the EUR/CAD; at the end of Q1, we expect the pair to reach 1.40. Finally, our longer-term forecast for the EUR/CAD in 18 months is 1.45 (18 months out).