The Canadian dollar climbed to its strongest level in five weeks on Friday, as a jump in oil prices and surprisingly solid retail sales data convinced traders that the Bank of Canada is increasingly likely to raise interest rates at its meeting next week.
The currency, often called the loonie, rose as investors weighed two forces that typically move money into and out of Canada: the price of crude oil, one of the country's biggest exports, and the outlook for interest rates, which affects how attractive Canadian assets are to global investors.
Oil and spending give the loonie a lift
On the energy side, oil prices climbed on renewed worries about supply disruptions in the Middle East. Because foreign buyers need Canadian dollars to pay for Canadian crude, higher oil prices tend to boost demand for the loonie.
On the economic side, Statistics Canada reported that retail sales rose 1.2% in August, a stronger reading than many analysts had expected. An early estimate pointed to another 0.7% gain in September, suggesting that consumer spending is holding up better than feared.
Desjardins, one of Canada's largest financial institutions, said the data fit with solid third-quarter growth. As a result, markets now put the odds of a Bank of Canada rate hike next week at about 80%, up from roughly 50% earlier in the week.
Those expectations also showed up in the bond market. The yield on the 10-year Government of Canada bond rose to 3.838%, moving in tandem with US Treasuries as investors adjusted to the possibility that interest rates could stay higher for longer.
What a rate hike would mean
The Bank of Canada has been on a tightening path for over a year, raising its benchmark rate to combat inflation. A hike next week would mark another step in that campaign, and it would signal that the central bank believes the economy is strong enough to withstand higher borrowing costs.
For everyday Canadians, the most immediate impact of higher rate expectations is often felt in the mortgage market. Even before the Bank of Canada makes a formal announcement, longer-term government bond yields can move when investors anticipate tighter policy. Banks and other lenders typically use those yields as a benchmark for pricing fixed-rate mortgages and other multi-year loans, adding a margin for risk and profit.
That means borrowing costs can shift on expectations, not just on the day the central bank announces a decision. If bond yields stay elevated, mortgage renewals and new fixed-rate offers are more likely to remain under upward pressure.
What it means for investors
For investors, the currency move and the bond yield rise are signals about the health of the Canadian economy and the path of monetary policy. A stronger loonie can affect the earnings of Canadian companies that export goods, as their products become more expensive for foreign buyers. It can also influence the returns of international investors holding Canadian assets.
The rise in the 10-year yield is particularly relevant for anyone with a fixed-rate mortgage or a home equity line of credit, as those products are often tied to government bond yields. Even if the Bank of Canada holds rates steady, a sustained increase in bond yields could push borrowing costs higher.
Investors will be watching the Bank of Canada's decision next week, as well as any guidance about future moves. The central bank has said it is data-dependent, so upcoming inflation and employment reports will be key. If the economy continues to show strength, further rate hikes could be on the table, which would likely keep the loonie supported and bond yields elevated.
For now, the combination of firm oil prices and resilient consumer spending has given the Canadian dollar a boost, but the bigger question is whether the Bank of Canada will follow through with a hike and what that means for the broader economy.
