The USD/CAD exchange rate recently hit one month highs and is eyeing an upside breakout. Following the Bank of Canada’s interest rate hike in September, traders and investors are awaiting tomorrow’s Interest Rate Decision. If the BoC strikes a dovish note, the loonie could suffer. However, a more optimistic outlook from the central bank may push the exchange rate higher.
The Canadian dollar lost 5% against the US dollar in September. The reason was widening US-Canada yield differentials. In addition to that, crude oil prices fell on worries about a recession. A weaker than expected employment report could also provide support to the recent BoC rate hike.
The Employment Change report indicated that the economy lost 43,200 jobs in June. While the Non Farm Payrolls report showed an impressive increase of over 43,000 jobs, the economy is still operating in first gear. In fact, the annual growth rate of the GDP has been in the 1.5%-2.0 percent range over the last six quarters. The Bank of Canada’s preferred measures of core inflation did not show any signs of easing in August. This means that the underlying strength of the Canadian economy will be reflected in the Bank of Canada’s interest rate decisions.
The BOC is still a long way from its goal of low and predictable inflation. But the economy’s labor market has improved, and inflation expectations are at a record high. In a recent survey, the average of core CPI common measures climbed 5.3% year-on-year. This is the highest rate of any major developed economy.
Aside from the hawkish tone of the Fed, the BoC has taken a more cautious approach, downgrading the forecasts for growth in the coming years. The economy could face a technical recession in the next few quarters. A recent inflation figure revives the case for a 75-basis-point rate hike at the next meeting.
The Bank of Canada’s policy rate is now at 4.1% for two-year government bonds. This is the highest level of the ten largest developed economies. It is also the highest amongst the key central banks in the current tightening cycle.
The BoC is still concerned about the U.S. economy and the risk of a double dip in Europe. That said, the BoC is not ready to back off its rate hikes, and should be able to support the economy for as long as it takes to reach its goal of a 2% inflation rate.
The next week will be critical for the USD/CAD exchange rate. The release of the Non Farm Payrolls report, as well as the Michigan Consumer Sentiment data, will be the focus. While the unemployment rate has come down to 5.2%, the Participation Rate has declined, which is not a good sign for the economy.
In the short term, the key drivers of the currency remain the external factors. The strength of the USD combined with recent oil price declines has sent WTI oil to YTD lows. A further fall in the price of commodities would be a positive for the Canadian dollar. But with the US Federal Reserve set to announce a 75 basis point rate hike on November 2, the currency will have to find other sources of support to break out of its current range.
