A New Hawk on the Horizon: The BOC

You’re going to hate me for saying this but… I told you so! I’ve been raving about the strength of Canada’s economy for quite some time now, and it was really just a matter of time before the Bank of Canada came out with a really hawkish interest rate outlook.

Yesterday, the BOC “surprised” the markets by signaling that interest rate hikes aren’t that far off. The central bank indicated that economic recovery during the first quarter was stronger than initially expected and that they decided to upgrade their growth outlook to 3.7% from 2.9% for 2010. In addition, the bank believes that the economic activity in Canada will be back in full swing by the second quarter of next year.

What really got the Loonie bulls going was the removal of the bank’s conditional commitment to keep rates at 0.25% until the second quarter of 2010. After the release of statement, the USDCAD fell over 100 pips within the course of an hour! Similar movement was seen on the CADJPY, which also rose by almost 150 pips following the report. Look like risk aversion has nothing on the Loonie, yo!

Recent data seems to agree with this bullish sentiment towards the CAD. For one, the country’s core consumer price index for one rose by an annualized 2.1% in January, which was a tad higher than the bank’s 2.0% inflation target. On a month-on-month basis, Canada’s CPI jumped by 0.7%, which marked its sixth consecutive increase and its fastest rise since November 2008.

The recent retail sales account also showed some promising advances. Sales grew by 0.7% in January while the previous month’s figure was revised up from 0.4% to 0.5%. Similarly, the core version of the account, which excludes automobiles sales because of their volatility, also expanded by 1.8%. This increase was almost four times the 0.5% consensus. It looks like all those government’s temporary tax credit helped boost sales for a year-over-year jump of 6% during the period.

Most importantly, Canada’s gross domestic product grew by 0.6% in January, its biggest monthly gain in three years while marking the fifth straight month of economic expansion! The better-than-expected rise in GDP suggests that the economy is picking up faster than economists have predicted.

Looking ahead, though, I think that the Loonie will have difficulty posting major gains against the dollar. I have a hunch that of all these good news and potential rate hikes could have already been priced into the markets by the time the BOC actually does raise rates. With that said, we may not see as strong reaction as we saw yesterday. Chances are we will probably see the USDCAD head in and out parity for the next few weeks.

For the meantime though, look for the Loonie to maintain the pace and be one of the favorites for the best performing currency for the first half of 2010.