Traders say lack of Bank of Canada guidance fuels volatility

By Randall Palmer and Leah Schnurr

OTTAWA, Feb 27 (Reuters) - When Bank of Canada Governor Stephen Poloz abandoned a policy of offering forward guidance on interest rates last year, he said telling traders explicitly what's going to happen can boost volatility as it spurs a rush for the exits when things change.

But traders say that so far the policy shift has in fact increased volatility with the central bank blindsiding markets with its surprise rate cut in January, and then catching them off guard again this week with comments by Poloz suggesting it will hold rates steady next month.

"How fast the market is flip-flopping around on interest rates in Canada has been quite remarkable," said Amo Sahota, director at Klarity FX in San Francisco.

When Poloz set out his reasons for eliminating forward guidance in a paper (http://bit.ly/1LQhJPC), he said one of his goals was "to shift some of the policy uncertainty from the central bank's plate back unto the market's plate".

By offering transparency on the economic risks the central bank is weighing, the idea is that markets will trade off new data and become "two-way and less vulnerable to unusual leveraging and volatile shifts".

Poloz reiterated on Tuesday that it is healthier for the central bank to lay out how it sees the economy and then let markets draw conclusions about rates.

Drawing such conclusions hasn't been easy for traders, partly because of what they perceive as the bank's mixed messages.

Just a week before the oil-price-driven rate cut in January, Deputy Governor Tim Lane said the plunge in crude prices would not have a drastic impact on growth in Canada, a major oil exporter.

After the 25-basis-point rate cut, designed to stimulate the economy, and after what was seen as a dovish speech by Senior Deputy Governor Carolyn Wilkins on Feb. 10, investors ramped up their bets on another rate cut to more than a 70 percent probability.

Those bets dropped to less than 30 percent after Poloz's comments on Tuesday.

CIBC World Markets director of foreign exchange strategy Bipan Rai noted the Canadian currency's trading range has been the widest in years recently.

"Whenever there is now a Bank of Canada speaker on the data calendar, everyone goes into duck-and-cover mode because they don't have any inclination of what could come out," said Brad Schruder, director of foreign exchange sales at BMO Capital Markets.

"The reputation of the bank might be more important than their actual stewardship, and right now it is net-net not extremely positive."

To be sure, not all market participants see volatility as bad. "The lack of forward guidance makes for a slightly hairier market but in some ways that means more opportunity," said Adam Cole, global head of foreign exchange strategy at RBC Capital Markets in London.

The Bank of Canada declined to comment, citing a self-imposed blackout period ahead of its March 4 rate decision.

Schruder said the volatility can have real-world consequences, cutting into the available credit that companies have to hedge foreign exchange exposure.

Greater uncertainty has also driven some participants out of the market for the Canadian dollar, which can reduce liquidity and fuel more violent moves, he said.

"It's not like the Bank of Canada should lead the market by the hand, but most certainly given the lack of actual data signals that triggered the move, without forward guidance, markets don't have very much to go on at this point," said Emanuella Enenajor, Canada and U.S. economist at Bank of America-Merrill Lynch in New York.

(Editing by Jeffrey Hodgson; and Peter Galloway)