Derek Halpenny at MUFG highlights that the Canadian Dollar (CAD) has held up well versus the US Dollar since the Middle East conflict began, with markets expecting the Bank of Canada (BoC) to keep rates unchanged but adopt a more hawkish tone. He sees higher, more persistent inflation risks and a short-term bias favouring the US Dollar (USD), though CAD should outperform other energy-importing G10 currencies in a re-escalation scenario.

BoC steady but more inflation focused

"In addition to the FOMC, the Bank of Canada meets today and an unchanged monetary stance is widely expected. We also get the release of the Monetary Policy Report and we will likely see a downward revision to GDP growth for this year along with an upward revision to inflation."

"In a de-escalation scenario it seems reasonable to us to assume that a retracement in energy prices will be to levels that are still higher than pre-conflict levels if you assume some amount of additional geopolitical risk premium is likely to remain. That means a higher level of inflation than assumed prior to the conflict that may become difficult to look through."

"However, at today’s meeting the backdrop will be no end in sight to the closure of the Strait of Hormuz while risk assets have remained resilient. We expect the BoC to therefore be certainly more hawkish than in March with some signs of a shift in focus toward upside inflation risks."

"Our short-term bias favours the US dollar based on the increasing prospect of re-escalation of the conflict and a further rise in crude oil prices. The latest IMM positioning data saw the largest week of CAD selling by Leveraged Funds since July 2024."

"While the Canadian dollar could underperform the US dollar in a re-escalation scenario, we would expect moves to be more modest and for CAD to outperform other energy import-dependent G10 currencies."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)