Tightening phase

Another supportive factor to the Canadian currency (especially the non-U.S. dollar cross rates) going forward is the resumption of an interest-rate tightening cycle by the BOC.

The BOC has begun raising rates in an attempt to slow the economy and reign in burgeoning inflation. As had been widely expected, the BOC pulled the trigger on a rate hike on Oct. 18, pushing the overnight rate 25 basis points (bp) higher to 3 percent, the highest level in more than two years. Thatmove was the second hike in 2005, after a 25-bp hike in September.

Also, in its policy statement, the BOC said additional rate hikes would be needed over the next four to six quarters to keep inflation on target. The central bank utilizes monetary policy to keep inflation near the midpoint of a 1- to 3-percent range.

Currency market participants recently honed in on the bank’s comments that the Canadian economy “appears to be operating at its full production capacity.”

“Previously, the BOC had predicted that wouldn’t happen until the second half of 2006,” Powell says. “The output gap has now closed.”

While ahead of the October rate hike, most analysts had expected the BOC to remain on hold at its next meeting on Dec. 6. Now analysts say the forecasts have shifted. Most market watchers expect another 25-bp hike in December, which would bring the overnight rate to 3.25 percent by year end.

Looking beyond that, Economy.com’s Buskas expects another 50 bps of tightening in 2006.