Bank of Canada expected to keep interest rate steady at 4.5%

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• Bank of Canada is likely to maintain key interest rates at 4.5% on Wednesday.
• BoC was the first major central bank to pause its interest-rate hiking cycle in March.
• Canadian Dollar is set for volatility on the BoC’s rate outlook.

The Bank of Canada (BoC) is expected to keep interest rates unchanged at 4.5% for the third meeting in a row on Wednesday after becoming the first major central bank to hit the pause button in March. USD/CAD struggles in two-week lows, just above 1.3400, ahead of the BoC policy announcements as the Canadian Dollar continues to draw support from increasing Oil prices.

Strong economic performance in Canada has also underpinned the Canadian Dollar at the expense of the USD/CAD pair. Canadian Gross Domestic Product (GDP) expanded 0.8% QoQ after showing no change in the previous quarter, recording the fastest pace since the second quarter of 2022. Canada’s real GDP grew at an annualized rate of 3.1% in the first quarter, following the 0.1% contraction in Q4 2022 and beating the market expectation for an expansion of 2.5%.

Meanwhile, Canada’s inflation unexpectedly rose in April, picking up for the first time in 10 months. The country’s annual Consumer Price Index (CPI) rose 4.4% in April, compared with a 4.3% increase in March. On a monthly basis, the CPI was up 0.7% in April, following a 0.5% gain in March.

Bank of Canada interest rate expectations: Steady monetary policy for a while

The acceleration in Canada’s headline consumer inflation, combined with a resilient Canadian economy, exerts pressure on the central bank to bring rate hikes back on the table. However, the Bank of Canada is widely expected to hold rates steady at 4.5% at its monetary policy meeting on Wednesday, with markets pricing about a 60% probability of such a move.

Some industry experts and banks are revising their calls, expecting the BoC to deliver 50 bps rate hikes by September, while others are predicting the central bank to resume its tightening cycle in September. Markets are looking forward to Friday’s May employment report from Canada to reprice rate hike expectations in the second half of this year. Canada added a higher-than-expected 41,000 jobs in April while the Unemployment Rate remained steady at 5%, near the record low of 4.9% seen in June and July 2022. 

Analysts at TD Securities (TDS) offered a more hawkish outlook on the BoC policy decision this Wednesday. “We look for the BoC to hike by 25bp in June, and 25bp in July. Ongoing economic resilience will lengthen the path back to 2.0% inflation and as such, we believe the BoC needs to tighten further,” they said.

“We were in the red zone for risks to further hikes, and this has pushed us to call for an additional 50bps of hikes (June, July) from here to bring us to 5% on the overnight rate. While market pricing is around 40% chance of a June hike, the reasons we are calling for a hike coupled with the market building towards a hike possibility are exactly why we continue to feel flatteners are the right way to skew,” TDS Analysts added.

When will the BoC release its monetary policy decision and how could it affect USD/CAD?

The Bank of Canada will announce its policy decision at 14:00 GMT. The policy announcements will not be accompanied by the central bank’s updated forecasts. There is no press conference to be held by Governor Tiff Macklem following the rates decision.

Should the BoC maintain rates at 4.5% but hint at a 25 basis points (bps) rate increase in July, the Canadian Dollar is expected to catch a fresh bid wave, hurting the USD/CAD pair. The major could also come under intense selling pressure if the central bank surprises with a 25 bps rate lift-off to 4.75%. The 1.3300 round figure could be then on USD/CAD sellers’ radars.

The Canadian Dollar could witness “sell the fact” trades in case the BoC holds rates and remains ambiguous about the future policy path. USD/CAD buyers are likely to recapture 1.3500 and beyond on a dovish hike.

Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for the USD/CAD: “The pair confirmed a Death Cross on the four-hour timeframe in Wednesday’s Asian trading after the bearish 50-Simple Moving Average (SMA) cut the flattish 200 SMA from above. This suggests that risks remain skewed to the downside for the USD/CAD pair, especially with the Relative Strength Index (RSI) also sitting way below the 50 level.”

Dhwani also outlines important technical levels to trade the major: “Sellers are likely to challenge the 1.3350 psychological level if USD/CAD sees a fresh leg lower in its ongoing downtrend. The next key support is seen at the May 10 low of 1.3335. Alternatively, immediate resistance awaits at the 21 SMA, pegged at 1.3424. Acceptance above the latter is critical to initiate a meaningful recovery toward the 1.3500 round figure.”