Jane Foley, Research Analyst at Rabobank, suggests that the combination of better than expected Canadian Q4 GDP report and an improvement in the price of oil gave further support to the CAD’s six week recovery vs. the USD and ensured the CAD remains the best performing G10 currency on a 5 day view. Key Quotes “This week Brent crude prices have recovered to levels last seen in early January. Better than expected US durable goods data and an upward revision to US Q4 GDP growth have boosted hopes for a recovery in demand for oil. While we are expecting a moderate recovery in oil prices by year end, we are also wary of being optimistic. There is little real change to concerns over oversupply particular given the recent dismissal of supply cuts by the Saudi oil minister. Another sustained drop in the oil price would have bleak consequences for the outlook for growth in the Canadian economy. In Q4 Canadian GDP grew at a pace of 0.8% saar q/q, comfortably above the flat outcome that the market consensus was pointing to. This corresponds to a real growth rate of 0.2% q/q and follows a 0.6% q/q rise in Q3. The overall pace of growth in the economy last year at 1.2% was less than half of the 2.5% growth rate recorded in 2014 and was indeed the most sluggish annual expansion rate since the 2009 recession. One of the positive contributions to Canadian GDP in Q4 came from net trade. This was led by a 2.3% q/q drop in imports, the third consecutive quarterly decline. The weakness of imports is likely a function of the weakness of the CAD. However, it also castes a negative light on the strength of domestic demand which rose by a sluggish 0.2% in Q4. Unfortunately, the softness of the CAD did not manage to spur exports which dropped 0.6% in Q4 albeit after a more encouraging 2.6% q/q gain in the previous quarter. As expected business investment was weak. The weakness of oil prices has dealt a heavy blow to investment and jobs in the energy sector. Business investment dropped 1.7% q/q in Q4 and was the fourth consecutive quarterly decline. Although yesterday’s GDP report was better than expected, there was still little to celebrate. The weakness of GDP clearly increases the risks to the country’s finances. Finance Minister Morneau has pledged to boost growth while also lowering the federal debt to GDP ratio, but continued weak growth would clearly question his ability to do so. Morneau’s budget due on March 22, should bring further clarity to the outlook but the indications from the February 22 federal pre-budget economic update were not encouraging. Even before fulfilling its election pledge of boosting spending, the government has revealed a ballooning in the underlying deficit projection for the fiscal year 2016-2017 of CAD 18.4bn (from 3.9bn) and 15.5bn for 2017-2018. The government assumes real GDP growth of 1.4% in 2016 and 2.2% in 2017 which might prove to be slightly optimistic particularly if the oil price remains depressed. The direction of the oil price will continue to be instrumental to both the outlook for the Canadian economy and the CAD. Also impacting the outlook for both is the relative strength of the US economy. A better tone in some recent US data releases has caused the market to question whether it was hasty in pricing out the risk of US rate hikes this year. A strengthening in the US economy should lend support to Canada’s external sector but it could also result in the CAD losing ground vs the USD; we still see scope for up to two Fed rate hikes this year. For this reason, and given also the vulnerability of the oil price we see scope for further upside in CAD vs. the USD as being limited this year and can’t rule out the risk of another spike above USD/CAD1.40 on a 6 mth view. Assuming a strengthening in growth and oil prices in 2017, we expect a better tone in the CAD to hold towards the turn of the year.” For more information, read our latest forex news.