Today, the Bank of Canada (BoC) will announce its monetary policy decisions, and Governor Tiff Macklem will speak about the policy outlook. It is expected that the BoC will raise its policy rate by 25 basis points to 5%. In early European trading, the USD/CAD exchange rate reached its lowest level since late June, trading near 1.3200.
It is not surprising that a currency rises in response to a rate hike. However, in the case of the BoC, investors do not always look beyond the current decision, as the bank has been known to play tricks with the markets. This may lead to a significant reaction, particularly in the USD/CAD exchange rate.
Unlike the U.S. Federal Reserve (Fed) and the European Central Bank (ECB), the BoC does not feel the need to pre-commit its decisions. The larger central banks aim to provide certainty, something that the BoC does not feel restricted by.
In the previous decision in June, the BoC surprised investors by raising rates from 4.50% to 4.75%, after leaving rates unchanged twice in a row and hinting that it was finished increasing borrowing costs. Governor Tiff Macklem and his colleagues indicated that the hike was a one-time reaction to stronger data. However, this decision left markets in disbelief.
In three of its most recent actions, the BoC caught the markets off guard:
source: tradingeconomics.com
Officials have recently commented on the need to fight inflation, and a positive jobs report has raised expectations for another increase in the upcoming meeting. The Federal Reserve’s hawkish stance, projecting two more rate hikes after pausing, has also increased expectations. However, if the BoC decides to hike interest rates, it would be a surprise and could send the USD/CAD tumbling down.
Here are three reasons why a BoC interest rate hike could result in a fall in the USD/CAD:
1) Uncertainty and fear of further increases – the market may remain worried about future moves even if the BoC promises to leave rates unchanged after this hike. This “dovish hike” would be met with skepticism, and markets would await further moves, supporting the Canadian Dollar.
2) Inflation is falling in Canada – the Consumer Price Index (CPI) fell to 3.4% in May, and Core CPI missed estimates, sliding from 4.1% to 3.7%. This is significantly below the U.S’s 5.3% for the same month and substantially below interest rates. If the BoC extends its tightening cycle and pushes borrowing costs to highly restrictive territory, investors would worry that the BoC would not stop until inflation fully returns to the bank’s 2% target. Such hawkishness would give the Canadian Dollar an advantage.
3) Inflation is falling in the U.S.f – a few hours before the BoC announces its decision, Washington’s statistics agencies release a fresh inflation report for June, expected to show a drop in headline inflation to 3.1% YoY and Core CPI to 5%. Investors expect one more hike in the U.S. and are happy to see the end of the tightening cycle. This contrast with a stubborn BoC could send USD/CAD tumbling down.
This is significant as roughly 75% of Canadian exports go south, and both countries have an extensive trade agreement that encourages even closer ties. Therefore, Canada’s smaller northern economy heavily depends on the southern one.
It’s important to consider the possibility of the Bank of Canada leaving interest rates unchanged, despite their tendency to surprise. This decision would be in response to concerns about weaker inflation and a potential U.S. economic slowdown.
However, if the BoC does not raise rates as expected, the Canadian Dollar could experience a significant drop in value, particularly against other currencies.
It’s worth noting that even if the BoC does raise rates, there could still be a downside move in the USD/CAD exchange rate.
Credit Suisse predicts that a 25 basis point hike and hawkish guidance from the BoC could push USD/CAD towards their end-Q3 target of 1.31.
The bank expects the BoC to maintain a hawkish stance, potentially indicating further rate increases in the future. This could lead to an increase in short-term policy tightening expectations and provide positive support for the Canadian Dollar.
Despite this, Credit Suisse remains optimistic about the CAD and maintains its end-Q3 target.
USD/CAD Short (Sell)
Enter At: 1.31938
T.P_1: 1.31000
T.P_2: 1.30286
T.P_3: 1.29543
S.L: 1.33178
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