HomeContributorsFundamental AnalysisCan a Sidelined Bank of Canada Prove Positive for the Loonie?

Can a Sidelined Bank of Canada Prove Positive for the Loonie?

In March, the Bank of Canada became the first major central bank to stop raising interest rates, with investors now assigning a small probability for a rate reduction at Wednesday’s gathering. What will policymakers decide, what signals will they provide with regards to their future course of action, and how may the loonie respond?

BoC expected to stand pat but to cut rates later this year

At its last meeting in March, the Bank of Canada decided to keep its policy rate untouched at 4.5%, becoming the first major central bank to hit the pause button in this race to bring inflation to heel. Although in their statement policymakers re   terated that they remain prepared to increase rates further if needed, they also noted that data remains in line with their expectations that CPI inflation will come down to around 3% in the middle of the year.

Post-meeting data showed that most inflation metrics in Canada slowed by more than expected in February, reaffirming the Bank’s view and prompting investors to assign an almost 15% chance of a rate cut as soon as at next week’s gathering, with the remaining pointing to no action. They are also anticipating nearly 50bps worth of rate reductions by December, although most economists polled by Reuters believe that the Bank will stay sidelined through the whole of 2023.

Recent data does not justify rate cut bets

However, last Thursday, the employment report for March confirmed that the labor market remains tight, a view already shared by the BoC’s business outlook survey, which was released a few days earlier. What’s more, according to the same survey, half of Canadian businesses anticipated a mild recession next year, which is fewer than the prior survey showed. As for inflation, although firms’ expectations moderated, they still see inflation well above 2% until at least 2025.

All this corroborates investors’ view that the Bank is more likely to stay on hold at this week’s gathering. However, it does not justify expectations of rate reductions. Yes, the full effect of prior hikes is not yet fully transmitted to the real economy, but there is no evidence that inflation will return to 2% soon and allow the Bank to start considering rate reductions.

Clues about future decisions to be the main driver for loonie

Putting everything together, all this means that if the Bank indeed decides to stand pat, the Canadian dollar is unlikely to be moved by the rate decision per se. Traders are likely to focus on the accompanying statement and the updated economic projections for clues and hints on whether rate cuts are indeed possible this year. Anything confirming their view could weigh on the loonie.

However, according to the data, that doesn’t seem to be the most likely outcome. Officials have ample reasons to push against rate reductions this year, which could help the Canadian currency gain ground. Now, whether the currency can hold onto its strength may depend on whether market participants will put full trust in the Bank’s words or continue pricing in some basis points worth of cuts by the end of this year.

Dollar/loonie stays below medium-term uptrend line

Dollar/loonie was in recovery mode the last few days, but today, it hit resistance at the crossroads of the uptrend line drawn from the low of June 8, the 1.3525 level, and the 100-day EMA. This implies that the sellers could soon jump back into the action. If so, they may easily overcome the low of April 4 at 1.3400 and drive the battle toward the key support area of 1.3230. If there are no buyers to be found near that zone either, a break could pave the way for a test at a longer-term uptrend line, drawn from the low of June 1, 2021.

The move signaling that the bulls have gained the upper hand again may be a recovery above the 1.3650 zone. Dollar/loonie would be above all the plotted moving averages, and above the uptrend line drawn from the low of June 8, allowing the bulls to climb to the 1.3810 barrier. The break of that barrier could carry extensions towards the 1.3980 zone, the pair’s highest point since May 2020, reached on October 13.

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