Canada Interest Rate Decision Preview: BoC set for third consecutive pause

• Canadian central bank is forecast to leave the key interest rate unchanged at 5.0% on Wednesday.
• Bank of Canada policymakers are expected to offer little changes to the guidance.
• 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% for the third consecutive time on Wednesday when it concludes the December policy meeting. The Canadian Dollar (CAD) has been steadily rising against the US Dollar (USD) after USD/CAD broke below 1.3650 two weeks ago, driven by a weaker Greenback across the board. During the current week, the pair rebounded from two months lows below 1.3500, rising to 1.3560.

At the final meeting for 2023, economists expect no changes from the BoC. Canada's economy has had a mixed performance since October. During the third quarter, economic activity contracted, but the central bank anticipates a recovery in the current quarter. Inflation in Canada remains above the 2% target but is moving closer to it. In October, the Consumer Price Index (CPI) rose by 3.1% compared to the same month last 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," said Tiff Macklem, Governor of the Bank of Canada, following the October meeting. He further stated that the decision to keep interest rates unchanged aimed to allow monetary policy sufficient time to moderate the economy and alleviate price pressures. Achieving that objective is not yet complete. 

Even if inflation reaches the BoC target, it would still require data to indicate that it will remain at that level or below on a sustained basis. However, there is still a long way to go for that scenario to unfold and for the data to reflect it. No “mission accomplished” is likely in the short term. Governor Macklem has stated that it is not the appropriate time to discuss interest rate cuts. This stance will likely continue, and any potential change in that position would only occur early in 2024 if the economy experiences a significant contraction and the labor market data raises concerns.

In October, the BoC decided to keep the policy rate unchanged at 5% for the second time. They reiterated their preparedness to hike rates further if necessary, expressing concerns about the persistence of underlying inflationary pressures. This hawkish bias is expected to prevail, with little room for a dovish surprise. 

A softer tone from the BoC is the only possible surprise, but it is improbable. The central bank's credibility is crucial, and they are expected to maintain a firm stance on inflation until they are convinced that it has returned to the target on a permanent basis. 

A rate hike from the BoC would also be a surprise since no analysts are currently predicting such a move. Labor market data from Canada released on Friday indicated that employment increased by 25,000 in November, surpassing expectations. However, the Unemployment Rate ticked higher to 5.8%. Full-time jobs primarily drove the positive change in employment, and wages (permanent employees) rose more than anticipated, with a 5% increase compared to the previous year. This data aligns with Macklem's statement in October, highlighting that the “Canadian labor market remains tight and wage pressures persist.” Nonetheless, the report was not a game-changer regarding monetary policy expectations.

A press conference won’t follow the last meeting in 2023, so it is more unlikely for the central bank to change its tone. Hence, the impact on markets is expected to be limited. The current debate in the market regarding interest rates revolves around when the central bank will begin cutting rates in 2024. Therefore, until the BoC offers new perspectives instead of maintaining a “hawkish hold”, the most significant inputs for the markets will continue to be economic data regarding inflation, labor market conditions, and growth.

“To return to low inflation and stable growth in the years ahead, we need these higher interest rates and slow growth in the short term. Our inflation target, our track record and our forceful response will get us through to the other side. We’re well on our way, and we need to stay the course,” Governor Macklem warned Canadians in a speech late in November. 

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 at 15:00 GMT on December 6 through a press release, which will briefly explain the decision. There won’t be a press conference, nor will the quarterly Monetary Policy Report (MPR) be released. The next MPR is scheduled for the next meeting on January 24, 2024.

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

An unexpected 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 area, followed by 1.3665 (confluence of the 20-day and 55-day SMAs). Above that level, the short-term negative bias would be negated.

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