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Brexit and the Canadian Market

June 24, 2016

Prime Minister Justin Trudeau says Canada can weather market turmoil after the U.K. voted to leave the European Union, while economists forecast the Bank of Canada is likely to continue to hold interest rates steady for longer or even cut them further.

Trudeau said in a statement Canada is well-positioned to endure economic uncertainty and pledged to “continue to build relations with both” the U.K. and EU. Bank of Canada Governor Stephen Poloz, Finance Minister Bill Morneau and fellow Group of Seven ministers and central bankers expressed confidence in the U.K. financial sector.

“We are monitoring the situation closely and we will be working with our partners around the world in order to maintain stability and create economic growth,” the prime minister told reporters Friday morning in Quebec City, adding that he had spoken earlier to both Morneau and Poloz. “They know the Canadian financial system remains strong and stable.”

The aftershocks from the U.K.’s Brexit vote are buffeting markets, while creating political upheaval in London, dismay in European capitals and panic on trading floors around the world. The pound plunged the most on record versus the U.S. dollar, global stocks tumbled and bonds and gold rallied. U.K. Prime Minister David Cameron resigned, saying he’d serve another three months, after a 52 percent majority rejected his pro-EU campaign.

‘Modest Drag’

The yield on the Canadian government 10-year bond fell 10 basis points to 1.187 percent as investors sought refuge in fixed income. The country’s currency declined 1.6 percent to C$1.2965, after earlier falling the most in six years. The S&P/TSX Composite Index dropped 1 percent, less than most global stock indexes, as a gold rally limited declines.

“I would see all of these moves as manageable” in Canada’s financial markets, said Eric Lascelles, chief economist at Royal Bank of Canada’s RBC Asset Management unit. “It will be a modest drag on Canadian growth, but I would stress the word modest.”

Other bank economists said the Brexit vote could cut 0.5 percentage points from domestic economic growth in the second half and lead the Bank of Canada to hold rates steady for longer. Interest-rate swaps show traders are pricing in a 32 percent chance of a Bank of Canada rate cut this year, up from 8 percent yesterday.

“The risk is still that the bank could conceivably cut in the event that the shocks that we’re looking at prove to be bigger than what we currently estimate,” David Tulk, chief Canada macro strategist at TD Securities, told Reuters.


TD Economics said the vote’s “financial and confidence spillovers could shave real GDP estimates by 0.5 percentage point or more in the second half of this year,” while Scotiabank said the vote, for the Bank of Canada, “will only add to long pause sentiment with a mild increase in cut risk expressed primarily through the currency.”

“Global economic growth remains lackluster and more uncertainty around this decision won’t help, with a Brexit magnifying the risks that already exist,” Jennifer Lee and Benjamin Reitzes, Toronto-based senior economists at BMO Capital Markets, said in a research note. They also pushed back their forecast for a rate hike to the fourth quarter of 2017, from the third.

The Bank of Canada is monitoring the situation closely, spokeswoman  Josianne Menard said in a statement. Lascelles said the central bank “would be prepared to act if needed.”

G-7 governors and finance ministers said they would “respect the intention” of the Brexit vote and remain united. “We affirm our assessment that the U.K. economy and financial sector remain resilient and are confident that the U.K. authorities are well-positioned to address the consequences of the referendum outcome,” they said in a joint statement.

Trade Ties

Canada’s exports to the U.K. totaled C$16.6 billion last year, or about 3.2 percent of the total, and fourth-most behind the U.S., China and the remainder of the EU.

Trudeau, who took power in late 2015 and has long fought against separatist forces within Canada, thanked outgoing U.K. Prime Minister David Cameron and pledged to continue working with the EU and U.K.

“The U.K. and the EU are important strategic partners for Canada with whom we enjoy deep historical ties and common values,” Trudeau said in his statement. “We will continue to build relations with both parties as they forge a new relationship.”

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