- Expected Rate Cut: The Bank of Canada (BoC) is widely anticipated to reduce its policy rate by 25 basis points, bringing it to 4.25%.
- Canadian Dollar Impact: The CAD has been weak against the USD but started to recover in late August.
- Inflation Trends: Headline inflation in Canada further decreased in July, supporting the case for a rate cut.
- Market Expectations: Swaps markets predict about 36 basis points of easing this week.
The Bank of Canada is expected to lower its policy rate for the third consecutive meeting on September 4, likely by 25 basis points, which would bring the benchmark rate down to 4.25%. This move aligns with the ongoing decline in Canadian inflation and a softer labor market.
The Canadian Dollar (CAD) has shown weakness against the US Dollar (USD) since the beginning of the year, with USD/CAD reaching highs near 1.3950 in early August. However, the CAD began to appreciate sharply later, pulling the pair down by about 5 cents by the end of the month.
In July, Canada’s annual inflation rate dropped to 2.5%, while the BoC’s core CPI fell below the 2.0% target, increasing by only 1.7% over the past year. This decrease in inflation and expected labor market easing support the anticipated rate cut.
Since inflation has remained below 3% since January, aligning with the BoC’s forecasts for the first half of 2024, the central bank is likely to continue making rate decisions based on economic data. Current market predictions suggest around 36 basis points of easing in September.
BoC’s Dovish Outlook
Despite the expected rate cut, the BoC is likely to maintain a cautious stance due to declining inflation and increasing slack in the labor market. BoC Governor Tiff Macklem recently stated that the economy is facing excess supply, particularly in the labor market, which is contributing to downward pressure on inflation. He emphasized the need for growth and job creation to absorb this excess supply and achieve a sustainable return to the inflation target.
The central bank aims to balance risks on both sides, striving to bring inflation back to 2% without significantly weakening the economy. Macklem noted that future decisions would be made cautiously, one meeting at a time.
Impact on USD/CAD
The BoC will announce its policy decision at 13:45 GMT on Wednesday, September 4, followed by Governor Macklem’s press conference at 14:30 GMT. The Canadian Dollar’s reaction will likely depend more on the BoC’s forward guidance than the rate cut itself. A conservative approach by the BoC may strengthen the CAD and lead to a dip in USD/CAD. Conversely, indications of further rate cuts could weaken the CAD, potentially driving USD/CAD higher.
USD/CAD has been on a downward path since early August, with the pair reaching monthly lows near 1.3640 last week. The recent rebound was primarily driven by the recovery in the USD, pushing the pair back above the 1.3500 level.
He adds, “The immediate target is the 200-day SMA at 1.3589. Clearing this region could lead to a revisit of the 1.3665-1.3680 band. If bears regain control, USD/CAD might test its August low of 1.3436 before potentially targeting the March low of 1.3419.”