Canadian Dollar edges higher ahead of BoC rate decision

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USD/CAD weakens to around 1.4050 in Wednesday’s early European session.
Traders see 10% odds of a Fed rate hike at the July 28-29 meeting.
The BoC is likely to keep its ‌key policy rate unchanged at 2.25% on Wednesday.

The USD/CAD pair loses traction to near 1.4050 during the early European trading hours on Wednesday. Traders expect the US Federal Reserve (Fed) to skip the July rate hike as inflation cools, weighing on the US Dollar (USD) against the Canadian Dollar (CAD). The US Producer Price Index (PPI) and the Bank of Canada (BoC) interest rate decision will be the highlights later on Wednesday.

The US Consumer Price Index (CPI) rose by 3.5% in the 12 months through June after surging 4.2% in May, the US Bureau of Labor Statistics showed on Tuesday. This figure came in softer than the market expectations of 3.8%. Excluding food and energy, the so-called core CPI increased 2.6% YoY in June after rising 2.9% in May, below the market consensus of 2.8%.

Traders have priced in nearly a 16.6% chance of a quarter-percentage-point rate increase at the Fed's July 28-29 meeting, versus 35% before the inflation report, according to the CME FedWatch tool. They give a hike at the Fed's September 15-16 meeting about a 60% probability, down from more than 90% before the release of the CPI data.

The BoC is widely expected to hold its benchmark overnight interest rate at 2.25% in its upcoming policy meeting on Wednesday. This would mark the sixth consecutive meeting with rates unchanged. BoC Governor Tiff Macklem said after the June decision that the Bank would look through the war-related near-term increase in inflation but would act if higher energy prices produced persistent inflation.

"It is really just about inflation that the bank focuses on, and if inflation pressures are still high, I don't know that the bank would necessarily move," said Pedro Antunes, chief economist at Signal49 Research.

Canadian Dollar FAQs

What key factors drive the Canadian Dollar?

The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada’s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.

How do the decisions of the Bank of Canada impact the Canadian Dollar?

The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.

How does the price of Oil impact the Canadian Dollar?

The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canada’s biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.

How does inflation data impact the value of the Canadian Dollar?

While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian Dollar.

How does economic data influence the value of the Canadian Dollar?

Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.