Canadian Dollar Forecast: Bank of Canada Heading Towards a Final Rate Hike
15:49, 24 January 2023
Bank of Canada Preview
Overview: The Bank of Canada is scheduled to announce its latest monetary policy decision on January 25th and quite possibly the final rate hike in this current cycle. As it stands, money markets are pricing in a 70% probability of a 25bps rate hike, to take the overnight target to 4.5%. A reminder at the last meeting, the BoC added flexibility to its forward guidance, stating that the governing council will consider whether the interest rate needs to rise further, which in turn has raised expectations that the bank will hit the pause button after this month.
Data: Economic data has been somewhat mixed, while inflation has been heading in the right direction with the headline rate at 6.3% from 6.8% and the average of core inflation down to 5.63% from 5.76%, the figures remain uncomfortably high. What’s more, as shown in the most recent employment report, the labour market remains tight with the economy adding 104k jobs in December, significantly above the estimate for 8k jobs created. However, a key input into the BoC’s decision-making is the business outlook survey, which showed that in Q4, rising interest rates have been dampening the outlook regarding firms’ sales expectations and investment plans, which provides the strongest case for the Bank of Canada to look at hitting the pause button.
Canadian Inflation
Canadian Inflation - Photo: Capital.com. Source: Refinitiv DatastreamCAD: According to the options market, the implied move for USD/CAD is 58pips (higher or lower from the spot price). As mentioned above the expectation is for the central bank to deliver a 25bps hike, however, the major focus is whether the central bank confirms that they have hit the peak interest rate. IF the BoC signals further hikes are needed, the Canadian Dollar would likely have a knee-jerk move higher (lower USD/CAD), although, as we have seen in recent months, rate hikes have not been the key driving force behind the Loonie’s performance and in fact, more rate rises may well be a detriment to the currency in the long run given the economy’s heightened sensitively to rising rates with regard to the housing market. On the flip side, a decision confirming that the BoC has indeed paused rate rises could see a somewhat muted reaction given that markets are priced for a pause going forward. The main takeaway is that the BoC’s rate decisions have not been the key driver for the currency (chart below) and thus outside of a knee-jerk reaction, this is likely to remain the case.
USD/CAD Reaction to Shock 100bps Hike
Canadian Dollar Chart - Photo: Capital.com. Source: TradingviewOn the technical front, USD/CAD continues to trade in narrow ranges as the Loonie lags the rest of the G10 during this softer USD environment. As long as equities and oil prices remain stable, USD/CAD can continue to drift lower towards key support at 1.3200-1.3310 where a closing break below opens the door to sub 1.30 in the pair.
USD/CAD chart: daily time frame
USD/CAD Daily Chart - Photo: Capital.com. Source: Tradingview