Bank of Canada steps on the gas

After having cut interest rates by a total of 150 basis points over three meetings in March to what was termed the “effective lower bound” of 0.25% it is no surprise that the Bank of Canada didn't move rates any lower today.

However, the fact the economy lost a million jobs in March underlines the need for further support and its financial system. Consequently, the central bank's announcement that they will step up their newly instigated quantitative easing efforts by buying provincial and corporate bonds in addition to the CAD 5bn of government securities it is buying weekly.

In an effort to better improve functioning in financial markets whilst also offering support for companies and regional governments the BoC is setting up a Provincial Bond Purchase Program of up to CAD 50bn and a Corporate Bond Purchase Program of up to CAD 10bn (investment grade only). It is also enhancing repo facilities to further help ease pressures in lending markets.

Separately, the central bank suggests that the peak to trough fall in Canadian economic activity – between 4Q19 and 2Q20 could be anywhere between 15 and 30%.

Canada is obviously impacted as much as everyone else by social distancing and shutdowns in an effort to contain Covid-19. However, its exposure to commodities, particularly, energy, which have seen dramatic price falls intensifies the downside risks for activity. The BoC also admits that the recovery, when it eventually comes, is likely to be uneven and could be protracted. Inflation is likely to fall to zero in the second quarter due to plunging gasoline prices.

We would suggest that the pace of recovery in Canada is likely to be slower than in other developed markets given the greater exposure to the energy sector

We do not disagree with the BoC's prognosis but remain hopeful that the peak to trough fall will be closer to 15% than 30% in GDP. That, however, depends on the pace of re-opening of the economy and if there are any setbacks on the number of Covid-19 cases that could prompt renewed shutdowns.

We would suggest that the pace of recovery in Canada is likely to be slower than in other developed markets given the greater exposure to the energy sector. The collapse in prices and demand means that investment in the sector is likely to continue being cut with employment prospects remaining challenging for some time to come.

Despite a quite muted reaction in USD/CAD around the BoC announcement, we keep seeing the balance of risks for CAD tilted to the downside in the short-term.

The root of all evil for the loonie is quite clearly the weak crude prices, that failed to sustainably recover after the new OPEC+ meeting as demand concerns kept rising.

With Western Canada Select crude currently trading around a historically-low 5 USD/bll (chart below), markets are starting to price in a grapple effect on the oil-export-centred Canadian economy. As long as crude prices prove unable to recover, the ability of CAD to rebound will inevitably be limited.