Canadian Dollar softens ahead of Fed, BoC rate decisions

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The USD/CAD pair trades with mild gains around 1.3700 during the early European trading hours on Wednesday. Markets turn cautious ahead of critical interest rate decisions from both the Federal Reserve (Fed) and the Bank of Canada (BoC) later on Wednesday.

USD/CAD posts modest gains near 1.3700 in Wednesday’s early European session.
Markets expect the Fed to leave interest rates unchanged at its March meeting.
The Bank of Canada is likely to hold interest rates steady on Wednesday.

The Fed is widely expected to keep interest rates unchanged at its current target range of 3.50%–3.75% at the conclusion of its two-day policy meeting on Wednesday. Escalating tensions in the Middle East and oil price spikes have complicated the inflation outlook, making a rate cut highly unlikely at this time. Traders scaled back Fed easing expectations, with markets now assigning about 25 basis points (bps) of cuts this year, according to a Reuters poll.

Markets will take more cues from Fed’s Powell speech, as it might offer some hints about the US interest rate path. Any hawkish comments from Fed officials could underpin the Greenback against the CAD in the near term.

The BoC is likely to hold interest rates steady at 2.25% for a third straight meeting on Wednesday as policymakers weigh the inflation risk of higher oil prices against a string of weak economic numbers. “The Bank of Canada won’t rush to respond without clarity on the size and duration of the oil price shock,” said Claire Fan, an economist with the Royal Bank of Canada.

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.