Despite the Bank of Canada’s recent decision to cut interest rates by 50 basis points for the second consecutive time — a move many anticipated — the Canadian dollar actually strengthened rather than weakened. In the wake of the rate cut, the loonie gained about half a U.S. cent. This surprising outcome stems from the belief that the Bank of Canada may adopt a more gradual pace for future rate cuts and might even pause its easing cycle sooner than expected.
“Bad news is, to a large extent, already factored into the exchange rate, and traders have been preparing for a widening gap between U.S. and Canadian policy rates for months,” Karl Schamotta, Chief Market Strategist at Corpay Currency Research, noted after the Bank of Canada lowered its borrowing rate from 3.75% to 3.25%.
Economist David Rosenberg also offered his perspective, stating, “The loonie seems to believe the Bank of Canada may pause its rate cuts, as evidenced by its rally following the decision.” Rosenberg is the founder of Rosenberg Research & Associates Inc.
Derek Holt, Vice-President and Head of Capital Markets Economics at the Bank of Nova Scotia, added that the Canadian dollar was “among the strongest currencies on the day,” reflecting the uncertainty the Bank of Canada signaled regarding future rate cuts.
Despite this, the Canadian dollar has faced challenges this year against the U.S. dollar. The loonie has fallen by 6.5% so far in 2024, lingering just above 70 U.S. cents, down from nearly 75.5 U.S. cents at the start of the year.
A variety of factors have pushed it down, including the ongoing strength in the U.S. economy and, more recently, a threat by Donald Trump that he would impose a 25 per cent tariff on all goods entering the U.S. from Canada and Mexico on day one of his presidency.
Diverging paths on interest rates haven’t helped, either.
The Bank of Canada has cut rates five consecutive times this year for a total of 175 basis points, while the U.S. Federal Reserve has trimmed rates twice by a more modest 75 basis points. Markets predict there is an 85 per cent chance the Fed will cut rates again when it meets next Wednesday.
A country’s policy rate affects the value of its currency because higher interest rates attract investors looking for a better return, which increases demand for that country’s currency and, therefore, its value.
The Bank of Canada on Wednesday indicated that future rate cuts are not guaranteed and upcoming decisions will be made on a case-by-case basis.
Nevertheless, economists are forecasting rates in Canada to land in the range of two per cent to 2.5 per cent by the end of the first half of 2025.
An improvement in the Canadian economy and a deterioration south of the border could boost the loonie modestly, he said.
“Any upside will be limited, and downside exposures will remain significant,” he said of the Canadian dollar’s prospects.