What to expect from the Bank of Canada?

Bank of Canada (BoC) is set to announce its next monetary policy decision tomorrow at 3:00 pm BST. Decision looks to be a close call with BoC members having to decide whether to hold rates unchanged or deliver a 25 basis point rate.

Economists expect a hold…

Bank of Canada refrained from making changes to the level of interest rates at two previous meetings. While BoC did not explicitly say that the rate hike cycle is over, lack of action in recent months served as a strong indication that it was over indeed. Economists surveyed by Bloomberg also seem to share this view as 29 out of 37 survey respondents expect rates to be left unchanged. The remaining 8 expect a 25 basis point rate hike.

…but money markets see a chance for a hike

However, money market odds have been on the rise recently and currently price in an almost-48% chance of a 25 basis point rate hike at a meeting tomorrow. This increase in hawkish bets can be to some extent explained by recent better-than-expected data releases from Canada, especially last week's Q1 GDP reading and an unexpected rise in April's CPI. There was an expectation that the combination of a high-interest rate environment and high indebtedness of households would cause Canadian consumers to cut back on spending, weighing on the economy and allowing inflation to slow. However, no such thing happened and it cannot be ruled out now that BoC will resume rate hikes.

Another reason behind increased rate hike expectations is today's decision from the Reserve Bank of Australia. RBA delivered an unexpected 25 basis point rate hike and, given that Australian data has been less hawkish than Australian recently, markets started to see an increased chance of a 25 bp rate move from BoC as well.

Recent data from Canada

• Q1 GDP (annualized): 3.1% vs 0.0% previously (2.5% expected)
• Manufacturing PMI for May: 49.0 vs 50.2 previously
• Employment change for April: +41.4k vs +34.7k previously (+20k expected)
• Unemployment rate for April: 5.0% vs 5.0% previously (5.1% expected)
• CPI inflation for April: 4.4% YoY vs 4.3% YoY previously (4.1% YoY expected)
• Retail sales for March: -1.4% MoM vs -0.2% MoM previously (-1.4% MoM expected)
• Core retail sales for March: -0.3% MoM vs -0.7% MoM previously (-0.8% MoM expected)

Markets are currently pricing in an almost-48% chance of Bank of Canada announcing a 25 basis point rate hike tomorrow. Source: Bloomberg

A look at USDCAD

Taking a look at USDCAD chart at D1 interval, we can see that the pair has been trading mostly sideways as of late. Pair lost some ground recently and pulled back from the 1.3650 area. USDCAD is closing in on an upward trendline that has been limiting downward moves since mid-November 2022. BoC decision tomorrow is almost sure to result in CAD volatility jump as market pricing is almost 50-50 split between hike and hold, meaning that any decision BoC makes will be a surprise to some extent. 

A hawkish surprise - 25 bp rate hike - would provide support for CAD and exert pressure on USDCAD. A break below the aforementioned trendline may occur in such a scenario and should the pair finish the deal below this hurdle, it could be a sign that a deeper drop is looming. In such a scenario, 1.3225 area would be a near-term support to watch.

On the other hand, keeping rates unchanged could hit the Canadian currency. USDCAD would gain in such a scenario and a near-term resistance to watch will be 1.3525 area, marked with previous price reactions as well as 200-session moving average (purple line). 

CAD traders should also pay attention to the BoC policy statement. If no hike is delivered tomorrow, the statement may guide for a 25 bp rate increase at July meeting. Money markets currently fully price in 25 basis point of tightening by July meeting.

USDCAD at D1 interval. Source: xStation5