On September 4, the Bank of Canada (BoC) is anticipated to reduce its policy rate for the third time in a row, likely by 25 basis points, bringing the benchmark interest rate to 4.25%. This decision mirrors recent trends, as the central bank has previously adopted similar measures.
The Canadian Dollar (CAD) has experienced significant fluctuations this year. Following a period of decline against the US Dollar (USD) that saw the USD/CAD exchange rate peak at approximately 1.3950 in early August, the CAD has since appreciated, reducing the pair by about 5 cents by the end of last month.
Inflation trends have influenced this decision. In July, the headline Consumer Price Index (CPI) saw a decrease to 2.5% year-over-year, while the BoC’s core CPI fell to 1.7%, below the 2.0% target. This decline in consumer prices, coupled with anticipated easing in the Canadian labor market, is likely prompting the BoC’s expected rate cut.
Since January, inflation has remained under 3%, aligning with the central bank’s projections for early 2024. Core consumer price indicators have shown a consistent downward trend, with current market expectations indicating about 36 basis points of easing in September.
Despite the anticipated rate cut, the BoC is expected to maintain a cautious stance. The central bank has noted that excess supply and slack in the labor market are contributing to lower inflation. BoC Governor Tiff Macklem emphasized the need for balanced growth and job creation to absorb excess supply and meet the inflation target.
Following July’s rate cut, Macklem indicated that the economy is experiencing excess supply, and while the conditions for reaching the 2% inflation target are improving, more growth and job creation are necessary. He stressed that future decisions would be made based on careful consideration of economic data.
Taylor Schleich and Warren Lovely of the National Bank of Canada anticipate a 25-basis-point cut, the third consecutive reduction. They noted that the July CPI report supports this decision without controversy, although they caution that the labor market remains challenging, with the unemployment rate possibly reaching around 7% by year-end.
The BoC will announce its monetary policy decision at 13:45 GMT on September 4, with Governor Macklem’s press conference scheduled for 14:30 GMT. Market reactions will likely hinge more on the BoC’s messaging rather than the rate cut itself. A conservative approach could bolster the CAD and potentially lower USD/CAD. Conversely, indications of further rate reductions could weaken the CAD, leading to gains for USD/CAD.
Pablo Piovano notes that USD/CAD has been declining since early August, reaching monthly lows near 1.3640. The recent recovery, driven by a stronger USD, has pushed the pair above the 1.3500 mark. Piovano suggests that if USD/CAD clears the 200-day SMA at 1.3589, it might test higher resistance levels. However, if bearish trends persist, the pair could revisit August lows or even lower levels from March and December 2023.
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