Canadian dollar looks through rate cut and tariff mayhem

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The Canadian dollar rose after the Bank of Canada announced its seventh consecutive rate cut as investors appeared to look through the latest moves by policymakers.

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On Wednesday, the Canadian dollar was up 0.43 per cent to 69.6 cents U.S. after the Bank of Canada cut its rate by 25 basis points to 2.75 per cent.

The last time the rate was this low was in 2022, when the Bank of Canada was in the midst of a hiking campaign that would end with rates topping out at five per cent in July 2023. At the time, the Canadian dollar was trading in the range of 76 cents U.S. to 77 cents U.S.

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“Indeed, the currency market has been less reactive to news of late, in part because investors have seen tariff announcements quickly reversed or delayed, and because views on the U.S. economy have also turned less positive,” Avery Shenfeld, chief economist at CIBC Capital Markets, said in a note.

“That change in view on the U.S. outlook makes today’s rate cut in Canada seem less out of step with where Fed policy might head, albeit further out in the year,” he said.

Diverging rates between the Bank of Canada and the United States Federal Reserve have left the loonie vulnerable to losses as investorsflocked to its American counterpart’s higher borrowing rates.

That upper hand appears to have evaporated for the time being, with the U.S. dollar index, a measure of the greenback’s strength against a basket of other major currencies, now down 5.95 per cent from a two-and-a-half-year high at the start of the year.

Not that long ago, markets expected the Fed to hold rates for the foreseeable future on a strong economic outlook, a resilient job market and stubborn inflation.

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The outlook for the U.S. economy has since soured with Donald Trump in full tariff battle mode. Furthermore, U.S. inflation data on Wednesday showed a surprise cooling, giving the Fed some room to respond with rate cuts if the need arises.

The Bank of Canada, in its official statement on the rate cut, said it would have to weigh economic headwinds against a possible resurgence of inflation as tariffs boost prices.

Some economists have cautioned that the loonie, weakened by lower rates, will add to the risk of inflation as imports become more expensive due to tariffs.

“Although the Bank of Canada has been focused on the labour market and inflation, it cannot discount the risk of further (Canadian dollar) depreciation caused by the interest rate differential between the U.S. and Canada,” Naoum Tabet, fixed income investment director at Capital International Asset Management (Canada) Inc., said in a note. “A weaker Canadian dollar over a longer period could see pressure on Canadian inflation.”

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For the moment, markets have reduced their bets for future rate cuts.

Still, there are voices in the investor community who think tariffs will win out over inflation in the Bank of Canada’s estimation, making more rate cuts likely.

“If we are right, then the likely outcome for rates is a more dovish profile than currently signalled by the Bank of Canada, implying additional easing in the coming months, a scenario that should prompt further loonie weakness,” Nick Rees, head of macro research at MonFX Pte Ltd., said in a note.

• Email: gmvsuhanic@postmedia.com

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