Stalled domestic growth fails to dent Canadian Dollar gains

• USD/CAD retreats as higher oil prices underpin the Canadian Dollar.
• August brings a second consecutive month of stagnation for Canada’s economy.
• Both the BoC and Fed leave further interest rate rises on the table as inflation concerns persist.

Weaker-than-expected Canadian growth figures have failed to offset the support that rising oil prices are providing to the commodity-linked Canadian Dollar (CAD). USD/CAD remains under pressure on Friday despite a recovery in the US Dollar (USD) from earlier losses. The pair stands at around 1.3963 at the time of writing, marking its lowest level since mid-September.

Concerns that the US could restart military strikes against Iran after next week’s US midterm elections have lifted West Texas Intermediate (WTI) above $103 a barrel, its highest level since May. With Canada a major crude exporter, the increase in oil prices is lending support to the Canadian Dollar.

Monthly Gross Domestic Product (GDP) showed no change in August, Statistics Canada reported, falling short of expectations for 0.2% growth. The result marked a second consecutive month in which the economy failed to expand.

For September, preliminary estimates indicate a contraction of 0.1%. Falls in manufacturing and in mining, quarrying, and oil and gas extraction are set to more than offset increases in utilities and wholesale trade. On that basis, third-quarter growth would amount to 0.3% QoQ, equivalent to roughly 1.2% on an annualised basis.

Such a pace would fall below the Bank of Canada's (BoC) projection of about 2% annualised growth, set out in Wednesday’s monetary policy announcement. On Wednesday, the BoC lifted its policy rate by 25 basis points (bps) to 2.50%, delivering its first increase since 2023 as higher energy costs associated with Middle East tensions intensify inflationary pressures.

Describing the BoC’s tone as distinctly hawkish, Brown Brothers Harriman draws attention to its warning that “there could be a need to increase the policy rate further.” Policymakers also “lifted real GDP growth and headline inflation projections across the forecast horizon,” the bank notes, pointing to a stronger macroeconomic backdrop than previously assumed. Haddad places particular emphasis on the fact that the BoC now “sees headline CPI above its 2% target through Q4 2028.”

In the US, a sell-off in technology shares drove demand for government bonds earlier on Friday, lowering Treasury yields and weighing on the US Dollar. Disappointing earnings reports have left investors concerned about the returns on substantial AI expenditure. The Greenback has subsequently recovered, however: after touching 101.59, the US Dollar Index (DXY) has moved back above 102.00.

Expectations of further interest rate increases by the Federal Reserve (Fed) remain supported by persistent inflation and resilient US growth. September PCE figures showed inflation still running above the Fed’s 2% target, while the central bank left rates unchanged at 3.75%-4.00% on Wednesday. According to the CME FedWatch Tool, traders assign around a 75% probability to a rate rise in December.