Stalled domestic growth leaves Canadian Dollar gains intact

Higher Oil prices lift the Canadian Dollar, pushing USD/CAD lower.
August marks a second straight month of stagnation for Canada’s economy.
Further rate increases remain an option for the BoC and Fed as inflation concerns persist.

1.3963 is the approximate USD/CAD level at the time of writing. The pair is at its weakest since mid-September, declining on Friday despite a recovery in the US Dollar (USD) from earlier losses. Support from higher Oil prices for the commodity-linked Canadian Dollar (CAD) outweighs the impact of weaker-than-forecast domestic growth figures.

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Above $103 a barrel, West Texas Intermediate (WTI) has reached its highest price since May. The advance reflects concerns over a possible resumption of US military strikes against Iran after next week’s US midterm elections. Canada’s position as a major crude exporter means stronger Oil prices benefit the Canadian Dollar.

Against expectations of 0.2% growth, monthly Gross Domestic Product (GDP) was flat in August. Statistics Canada’s figures showed the economy stagnating for a second month in a row.

A September contraction of 0.1% is indicated by preliminary estimates. Weakness in manufacturing, mining, quarrying, and Oil and gas extraction more than offsets expansion in utilities and wholesale trade. This would put third-quarter growth at 0.3% QoQ, equivalent to roughly 1.2% annualised.

Such a pace would fall short of the Bank of Canada's (BoC) forecast for annualised growth of about 2%, set out in Wednesday’s monetary policy announcement. With energy costs driven higher by Middle East tensions adding to inflationary pressures, the BoC increased its policy rate on Wednesday by 25 basis points (bps) to 2.50%. It was the bank’s first rate rise since 2023.

A notably hawkish message from the BoC drew attention from Brown Brothers Harriman, which noted the warning that “there could be a need to increase the policy rate further.” According to the bank, policymakers “lifted real GDP growth and headline inflation projections across the forecast horizon,” signalling a stronger macroeconomic backdrop than previously assumed. Haddad places particular weight on the BoC’s assessment that it now “sees headline CPI above its 2% target through Q4 2028.”

In the US, lower Treasury yields weighed on the US Dollar earlier on Friday after a technology share sell-off drove demand for government bonds. Disappointing earnings reports have left investors concerned about the returns on substantial AI expenditure. The Greenback subsequently recovered, however. Having dropped to 101.59, the US Dollar Index (DXY) has moved back above 102.00.

Expectations of further Federal Reserve (Fed) rate increases remain underpinned by resilient US growth and persistent inflation. On Wednesday, the Fed left rates unchanged at 3.75%-4.00%, while September PCE figures indicated that inflation was still above its 2% target. According to the CME FedWatch Tool, traders assign around a 75% probability to a rate rise in December.

GDP: Key Questions

GDP: Definition and Measurement

Usually measured over a quarter, a country’s Gross Domestic Product (GDP) gauges the pace at which its economy grows during a specified period. The most reliable comparisons use either the preceding quarter, such as Q2 of 2023 against Q1 of 2023, or the corresponding period a year earlier, such as Q2 of 2023 against Q2 of 2022. To produce annualised quarterly GDP figures, the quarter’s growth rate is extrapolated on the assumption that it continues unchanged for the rest of the year. Temporary shocks can make these readings misleading if their effect on one quarter is unlikely to persist throughout the year. One example was the sharp fall in growth in the first quarter of 2020 as the covid pandemic began.

GDP and Currency Performance

An expanding economy is more likely to generate exportable goods and services and attract greater foreign investment. A higher GDP reading therefore generally supports a country’s currency, whereas a decline in GDP typically weighs on it. Economic expansion also tends to encourage spending, creating inflation. To counter that inflation, the central bank then needs to raise interest rates. Those higher rates can draw additional capital from international investors, helping the domestic currency strengthen.

Higher GDP Growth and Gold Prices

Stronger GDP growth usually weighs on Gold prices through its effects on spending, inflation and interest rates. As the economy expands and GDP rises, people generally spend more, generating inflation that the central bank then has to counter with higher interest rates. For Gold, rising rates are a negative: they increase the opportunity cost of holding the metal rather than keeping the money in a cash deposit account.