Analysts widely expect the BOC to keep rates unchanged at the end of its monetary policy decision on Wednesday. While the meeting itself can have important implications for CAD, many traders might be looking to the BOC for clues about what the Fed will do.
Canada’s and the US economies are closely linked, and the BOC faces many of the same economic conditions as the Fed. Because the Canadian meeting is just ahead of the Fed’s, policymakers can give some insight into how central bankers are thinking about specific issues. As a result, the market might adjust its expectations around the Fed, depending on what BOC Governor Tiff Macklem has to say about second-order inflation, for example.
BOC on Hold, USDCAD on FedWatch
Economists are unanimous in expecting the BOC to keep rates unchanged for the rest of the year, while the Fed is projected to hike. That means the main interest rate driver for the currency pair is likely to come from the American side, given the uncertainty about when the Fed will pull the trigger.
However, the BOC can still have a significant impact on the currency, as traders focus on the policy statement and on Macklem’s post-rate-decision press conference. After Fed Chair Kevin Warsh affirmed his commitment to raising interest rates, investors will be keen to see how central bankers view the consumer price landscape. Both the US and Canada are major fuel producers, but are also seeing higher energy costs as a result of the war in the Middle East.
Inflation and Trade Are the Key Issues
The relevant point for markets around inflation is whether central bankers believe higher fuel prices are being passed through to the broader economy. This is known as “second round” effects. If there are growing signs that energy prices are affecting other products that use energy for transportation and production, the central bank might be forced to act.
Counterintuitively, if Macklem notes second-round effects in inflation, this could weaken the CAD. That’s because the Fed is more likely to act before the BOC to deal with higher core inflation, even though both economies are likely to be affected. The issue with the Fed is the timing of the hike, but for the BOC, it’s whether they might hike well into the future.
Canadian Recovery Could Support the CAD
The breakdown of US-Canadian trade talks will likely be a factor in the BOC’s upcoming decision. Prime Minister Mark Carney threatened reciprocal dollar-for-dollar tariffs in response to Washington’s 50% levy on $20 billion in goods, set to take effect on September 8. The expectation is that those tariffs will raise consumer prices, but whether it will be enough to push the BOC into a slightly more hawkish mode is likely a question for Macklem.
If the BOC comes across as more concerned about tariff-driven inflation in the coming months, the market will likely take it as a hawkish sign. This could help shore up the CAD, which has recently recovered almost all of its post-tariff losses. On the other hand, concern about the economy would likely be interpreted as more dovish and could weigh on the CAD.
