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Bank of Canada Could Emphasize CAD Sweet Spot

Thursday’s Bank of Canada rate decision will be rightly overshadowed by Greece and the pending US and Canadian jobs reports on Friday but once the short-term smoke clears, the central bank will have outlined the case for a long-term CAD rally.

Economists and the market see no chance of a rate hike on Thursday, leaving the overnight rate at 1.00%, where it has remained since September 2010. The market is also pricing in almost no chance that rates are any different next March than then are right now.

The decision will feature no clear guidance on rate moves in the near future but will offer a clear indication that policymakers have seen improvement. The Bank of Canada forecast 2% growth this year but with European risks minimized and US economic trajectory improving, the consensus is moving higher.

New risks have emerged from Iran and China.

The run-up in the price of oil convinced US leaders that a war with Iran would be too costly at the gas pump. As a result, crude prices are coming down to levels that remain favorable to Canadian energy exports without stifling US spending.

Chinese leaders lowered growth estimates to 7.5% for this year after nearly a decade of sandbagging the market with 8% forecasts. The BOC is unlikely to be swayed by the change because it has also been accompanied by pledges to increase imports and lower import tariffs.

With inflation pressures low, the Bank of Canada has the luxury to wait until at least mid-summer before the market will start asking hard questions about raising rates but Thursday’s decision will be an opportunity to show that hikes are visible on the distant horizon.

Aside from more upbeat commentary, the BOC may change its key language on when the economy is anticipated to return to full capacity, or when the output gap will close. The current forecast is the third quarter of 2013. If that comes down, CAD will rally.

Even if the BOC decision is less-rosy than I anticipate, I see the Greek PSI deal proceeding as expected with the potential for upside surprises in US and (especially) Canadian jobs data. This should underpin continued Canadian dollar strength.

I shared more thoughts on CAD with a Reuters reporter in a story today: http://www.reuters.com/article/2012/03/07/markets-canada-dollar-bonds-idUSL2E8E7G2920120307

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