A Canadian dollar or loonie is pictured in North Vancouver, on March 5, 2014.The Canadian Press
The Canadian dollar and short-term bond yields slid, reversing course after Bank of Canada Governor Stephen Poloz said the central bank "actively" discussed the possibility of adding more stimulus into the economy.
The currency initially gained and bonds dropped after the central bank held its benchmark interest rate at 0.5 per cent and the BOC's policy statement dropped a reference to downside inflation risks that featured in its previous stance from September. The markets then did an abrupt u-turn after Mr. Poloz said policy makers discussed monetary easing "in order to speed up the return of the economy to full capacity."
"The fact that they considered a rate cut is significant," said Mazen Issa, a senior foreign-exchange strategist at Toronto-Dominion Bank in New York. "It could be more bark than bite, but nonetheless, the signaling effect is important."
The currency weakened 0.1 per cent to $1.3123 against the U.S. dollar as of 2:03 p.m. in Toronto, reversing a rally of much as 0.8 per cent. The rate on Canada's bond due in November 2018 fell three basis points to 0.56 per cent, after an earlier of two basis points.
The Canadian dollar's loss was limited by a surge in crude oil, Canada's second-largest export, after the Energy Information Administration reported that U.S. crude inventories unexpectedly fell last week.
The drop in the yield on Canada's two-year bond widened the premium investors demand to hold similar-maturity U.S. Treasuries to 24 basis points. With the Federal Reserve moving toward an interest-rate increase, there's a stronger case for more Canadian dollar weakness as the yield gap between Treasuries and Canadian bonds is set to widen.
Hedge funds and other large speculators ceased to bet in favor of the loonie last month after being bullish since April, according to net-positioning data from the Commodity Futures Trading Commission. The shift came after a Sept. 23 report showed Canada's inflation rate unexpectedly slowed to a 10-month low.
The loonie will trade at $1.32 against its U.S. counterpart by the end of the year and strengthen to C$1.29 by the end of 2017, according to forecasts compiled by Bloomberg.
Policy makers said Wednesday the risks were balanced around an updated 2017 consumer price forecast of 1.9 percent, from 2.1 percent previously. The central bank cut its growth forecast for this year to 1.1 percent from 1.3 percent, and to 2017 to 2 percent, from 2.2 percent.
Mr. Poloz said the interest rate at 0.5 percent is appropriate, albeit at a time of heightened uncertainty.
"Poloz sent the most dovish signal so far this year," Viraj Patel, a London-based foreign-exchange strategist at ING Groep NV, said in a note. "Limited conventional monetary policy room and heightened near-term uncertainties likely kept the central bank on hold for now, but Poloz's comments today confirm our view that markets are underestimating the risks of further easing."