Bank of Canada to keep interest rates on hold as growth concerns mount

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  • The Bank of Canada is forecast to leave the policy rate unchanged at 5.0% on September 6.
  • BoC policymakers are expected to keep the interest rate steady until the end of the year.
  • BoC policy statement could ramp up volatility around the Canadian Dollar.

The Bank of Canada (BoC) is widely expected to leave its policy rate unchanged at 5% when it concludes the September policy meeting on Wednesday, following the 25 basis points rate hike announced in July. The Canadian Dollar has been struggling to find demand since the previous BoC policy meeting and has lost nearly 2.5% against the US Dollar. 

The BoC’s latest Participants Survey, published on July 24, showed that most market participants expected the bank to hold its policy rate at 5% until the end of 2023. Moreover, participants also forecast the BoC to reduce the key interest rate to 3.50% in the fourth quarter of 2024.

Bank of Canada interest rate expectations: Steady policy as activity slows

The BoC had a batch of data releases to assess since the July meeting as it looks to set the monetary policy in a way to tame inflation, while limiting the damage to the economy.

After declining to 2.8% in June, the annual Consumer Price Index (CPI) inflation climbed to 3.3% in July. In the meantime, the Canadian economy stagnated in the second-quarter, following a 0.6% (QoQ) real Gross Domestic Product (GDP) growth recorded in the first. This reading came in below the market expectation for a 0.3% expansion. On a monthly basis, Canada’s real GDP contracted by 0.2% in June. 

Analysts at TD Securities (TDS) said that the latest GDP figures reaffirm that the BoC will opt to leave the policy rate unchanged:

“The below consensus print on Q2 GDP should give the Bank of Canada enough conviction that its rate hikes are working to step back to the sidelines in September, especially with interest sensitive parts of the economy leading the slowdown. The monthly figures for June & July also leave Q3 GDP tracking well below BoC projections which should help make the Bank’s decision a little easier next week.”

The BoC is likely to leave its policy unchanged to buy more time to assess the developments. Rising energy prices since August could cause the bank to adopt a cautious stance regarding the inflation outlook in its policy statement. Signs of cooldown in the labor market and consumer activity, however, could force the BoC to refrain from leaving the door open to additional policy tightening. Retail Sales ex Autos declined 0.8% in June, while the Unemployment Rate ticked up to 5.5% in July from 5.4% in June. 

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 on Wednesday, September 6, at 14:00 GMT. The policy decisions will not be accompanied by the central bank’s updated forecasts and there will not be a press conference by Governor Tiff Macklem following the release of the policy statement.

The Canadian Dollar (CAD) lost nearly 2.5% against the US Dollar since the BoC’s July meeting. Markets seem to have already priced in a no-change in the bank’s policy settings in September. At this point, a 25 basis points rate hike in response to stronger-than-forecast July CPI readings would be a significant hawkish surprise. Such a decision, however, is very unlikely given the gloomy economic climate.

If the BoC notes that it could consider another rate increase in case inflation proves to be more persistent than estimated, the initial market reaction could provide a boost to the CAD and trigger a leg lower in USD/CAD. 

On the other hand, USD/CAD could extend its uptrend if the BoC puts more emphasis on the growth outlook, while maintaining a neutral stance on inflation. In this scenario, even if a ‘buy the rumor sell the fact’ market reaction could initially weigh on the pair, it is unlikely to be persistent enough to trigger a downtrend.

Eren Sengezer, European Session Lead Analyst at FXStreet, offers a brief technical outlook for the USD/CAD pair and writes:

“The Relative Strength Index (RSI) indicator on the daily chart climbed above 70 this week, suggesting that USD/CAD could stage a downward correction before the next leg higher. Nevertheless, the bullish bias remains intact in the near term outlook.”

Eren also outlines important technical levels for USD/CAD: “1.3600 (psychological level) aligns as interim support ahead of 1.3550 (20-day Simple Moving Average), 1.3500 (psychological level) and 1.3450 (200-day SMA). On the upside, 1.3700 (psychological level) could be seen as first resistance before 1.3750 (static level from April) and 1.3860 (2023-high set on March 10).

Interest rates FAQs

Interest rates are charged by financial institutions on loans to borrowers and are paid as interest to savers and depositors. They are influenced by base lending rates, which are set by central banks in response to changes in the economy. Central banks normally have a mandate to ensure price stability, which in most cases means targeting a core inflation rate of around 2%.
If inflation falls below target the central bank may cut base lending rates, with a view to stimulating lending and boosting the economy. If inflation rises substantially above 2% it normally results in the central bank raising base lending rates in an attempt to lower inflation.

Higher interest rates generally help strengthen a country’s currency as they make it a more attractive place for global investors to park their money.

Higher interest rates overall weigh on the price of Gold because they increase the opportunity cost of holding Gold instead of investing in an interest-bearing asset or placing cash in the bank.
If interest rates are high that usually pushes up the price of the US Dollar (USD), and since Gold is priced in Dollars, this has the effect of lowering the price of Gold.

The Fed funds rate is the overnight rate at which US banks lend to each other. It is the oft-quoted headline rate set by the Federal Reserve at its FOMC meetings. It is set as a range, for example 4.75%-5.00%, though the upper limit (in that case 5.00%) is the quoted figure.
Market expectations for future Fed funds rate are tracked by the CME FedWatch tool, which shapes how many financial markets behave in anticipation of future Federal Reserve monetary policy decisions.



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