Canadian interest rate decision preview: Bank of Canada prepares for third consecutive pause

• The Canadian central bank is expected to keep the policy rate at 5% on Wednesday.
• Bank of Canada policymakers are expected to offer few changes to guidance.
• The BoC statement could increase volatility around the Canadian dollar.

The Bank of Canada (BoC) is expected to leave its policy rate unchanged at 5% for the third consecutive meeting on Wednesday. The Canadian Dollar (CAD) has been rising steadily against the US Dollar (USD) after USD/CAD broke below 1.3650 two weeks ago, boosted by an overall weaker USD. During the current week, the pair bounced from two-month lows below 1.3500, rising to 1.3560.

At the last meeting in 2023, economists do not expect any changes from the BoC. The Canadian economy has performed unevenly since October. During the third quarter, economic activity contracted, but the central bank expects a recovery in the current quarter. Inflation in Canada remains above the 2% target, but is approaching it. In October, the Consumer Price Index (CPI) rose 3.1% compared to the same month of the previous year.

Bank of Canada interest rate expectations: No change, no victory

“Inflationary risks have increased since July; inflation is on a higher path than we expected,” Bank of Canada Governor Tiff Macklem said after the October meeting. He further stated that the decision to keep interest rates unchanged was intended to give monetary policy enough time to moderate the economy and ease price pressures. The achievement of that goal has not yet been completed.

Even if inflation reaches the BoC’s target, data would still need to indicate that it will remain at or below that level on a sustained basis. However, there is still a long way to go for this scenario to develop and for the data to reflect it. “Mission accomplished” is not likely any time soon. Governor Macklem has stated that now is not the right time to talk about interest rate cuts. This stance is likely to continue, and any potential change to it would only occur in early 2024 if the economy experiences a significant contraction and labor market data raises concerns.

In October, the BoC decided to keep the official interest rate at 5% for the second time. It reiterated its willingness to raise rates further if necessary, expressing concern about the persistence of underlying inflationary pressures. This hawkish bias is expected to prevail, with little room for a moderate surprise.

The only possible surprise is a softer tone from the Bank of Canada, but it is unlikely. The central bank’s credibility is crucial, and it is expected to maintain a firm stance on inflation until it is convinced it is permanently back on target.

A rate hike by the BoC would also be a surprise, as no analyst expects it to happen. Canadian labor market data released Friday showed employment rose by 25,000 jobs in November, exceeding expectations. However, the unemployment rate rose to 5.8%. Full-time jobs mainly drove the positive employment change, and wages (regular employees) increased more than expected, with an increase of 5% compared to the previous year. These data are consistent with Macklem’s statements in October, in which he highlighted that “the Canadian labor market remains tight and wage pressures persist.” However, the report has not changed monetary policy expectations.

There will be no press conference after the last meeting in 2023, making it more unlikely that the central bank will change its tune. Therefore, the impact on the markets is expected to be limited. The current market debate on interest rates revolves around when the central bank will begin cutting rates in 2024. Therefore, until the BoC offers fresh perspectives instead of maintaining a “hawk stance”, the most Important for markets will continue to be economic data regarding inflation, labor market conditions and growth.

“To return to low inflation and stable growth in the coming years, we need these higher interest rates and slow growth in the short term. Our inflation target, our trajectory and our strong response will get us to the other side. We are doing well on track and we must stay the course,” Governor Macklem warned Canadians in a speech in late November.

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

The Bank of Canada will announce its monetary policy decision at 15:00 GMT on December 6 through a publication in which it will briefly explain the decision. There will be no press conference, nor will there be information on the quarterly Monetary Policy Report. The next report is scheduled for the January 24, 2024 meeting.

The impact on the CAD is expected to be limited. Aggressive stance could reinforce current USD/CAD bearish bias. However, it should be considered that much of the recent decline has been driven by USD dynamics. An even more hawkish tone should boost the Canadian Dollar across the board and potentially expose USD/CAD’s recent lows. The 200-day SMA at 1.3510 serves as a last defense before a more significant decline, initially pointing to September lows at 1.3370 and then a medium-term support level at 1.3300.

An unexpectedly softer tone from the Bank of Canada would likely weaken the Canadian Dollar, potentially pushing USD/CAD to break above 1.3600 and challenge the 1.3650 zone, followed by 1.3665 (confluence of the 20-day and 55-day SMAs). Above that level, the short-term negative bias would be nullified.

On Friday, USD/CAD posted its first weekly close below the 20-week SMA since August. The line currently sits at 1.3590, and another close below would indicate a consolidation of bearish momentum.