Canadian dollar loses momentum after BoC rate decision

Bank of Canada keeps rates unchanged for third straight meeting, CAD slides vs. USD

The Canadian dollar appreciated beyond the 1.35 per USD level after the Bank of Canada opted to maintain interest rates at a 22-year peak while signaling a relatively hawkish stance. The decision reversed CAD’s trajectory.

Despite keeping the key overnight rate steady at 5%, the bank hinted at the possibility of future hikes while expressing ongoing concerns about inflation. This comes amid acknowledgment of an economic slowdown and a general softening of prices.

Recent data revealed a dip in Canada's inflation rate to 3.1% in October, hitting a four-month low, with the core rate reaching a 28-month low at 2.7%. The economy also unexpectedly contracted by an annualized rate of 1.1% in the third quarter. Investors are now contemplating a potential rate cut as early as March.

Governor Tiff Macklem, however, stressed that the BoC is not currently considering easing measures, given that inflation remains notably above the target threshold.

The Bank of Canada’s decision matched that of other major central banks across the world, such as the Reserve Bank of Australia, which kept its key interest rate steady at a 12-year high of 4.35% earlier this week.

The upcoming week holds interest rate decisions from other major central banks, with the European Central Bank expected to maintain its rates at the current record high of 4%. The Federal Reserve (Fed) and the Bank of England (BoE) are also likely to keep rates steady the following week.

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Reuters poll shows Canadian dollar forecasts turn less bullish

According to a recent Reuters poll, analysts are revising their outlook for the Canadian dollar, foreseeing less potential for appreciation than previously anticipated in the coming year. This adjustment is driven by recent data revealing a slowdown in the domestic economy, prompting expectations of earlier interest rate cuts by the Bank of Canada.

The median forecast from a survey of 35 foreign exchange analysts conducted from December 1 to 5 indicates a weakening of the Canadian dollar by 0.4% to 1.3533 per U.S. dollar (equivalent to 73.89 U.S. cents) over the next three months, compared to 1.3450 in a November poll.

The Canadian dollar was then expected to advance to 1.3130 in a year’s time, versus 1.3000 in last month’s forecast.

The unexpected contraction of the Canadian economy at an annualized rate of 1.1% in the third quarter, though avoiding a recession after a revised upward growth in the previous quarter, has raised concerns about stumbling growth.

There is growing speculation that the Canadian central bank may start easing its policy as early as March. As recently as October, there were no anticipated rate cuts priced in for 2024.

A separate Reuters poll from the previous week aligns with this sentiment, with economists predicting that the Bank of Canada will begin cutting rates in Q2 2024, leading to a reduction in borrowing costs by at least one percentage point by the end of the following year.

The widening gap of 54 basis points between the Canadian 2-year yield and its U.S. equivalent in recent weeks, the largest since March, reflects the diminishing appeal of the Canadian currency, given that a lower yield typically makes a currency less attractive to investors.

CAD forecast: ING notes BoC’s “hawkish bias”

In an overview of the BoC’s decision, Francesco Pesole, an FX Strategist at Dutch bank ING, noted that the deterioration of both U.S. and Canadian growth sentiment next year would make CAD (known as the “loonie” in forex markets) less appealing than other risk-sensitive currencies:

“From a market perspective, the reiteration of the hawkish bias by the Bank of Canada is positive news for CAD, although the acknowledgement of faster inflation decline and the strong impact of tight monetary conditions on the economy have offset the impact on the loonie, which is holding steady after the announcement.

Despite the BoC’s reluctance to pivot to a more dovish stance, the loonie remains highly affected from a deterioration in US data, to which it has the highest correlation in G10. In the short term, the last bits of evidence of US activity resilience may support CAD – especially in the crosses – but we expect the worsening of US (as well as Canadian) growth sentiment next year to make CAD less appealing than other risk-sensitive currencies like the antipodeans and Scandies.”

At the time of writing, the USD to CAD exchange rate stood at $1.3600, with the greenback gaining close to 0.3% against the loonie over the past 5 days. The DXY dollar index — a gauge of the greenback’s strength against a basket of six major currencies — traded around the 104.09 mark.

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