Bank of Canada Preview: Dovish surprise to lift USD/CAD

• Bank of Canada is expected to leave its policy unchanged at 0.25%.
• Investors await adjustments to BoC’s asset-buying program.
• USD/CAD is likely to react more significantly to a dovish surprise.

The Bank of Canada is widely expected to keep its policy rate unchanged at 0.25% on Wednesday. However, the improving economic outlook and recent remarks from officials suggest that the BoC could become the first major central bank to lay out a roadmap out of the ultra-loose policy.

BoC set to lower QE purchases

The BoC’s Business Outlook Survey for the first quarter showed that the business sentiment continued to improve and the outlook indicator jumped to its highest level since 2018. Many firms reported that the negative impact of the coronavirus crisis on their activity was already behind them.

While commenting on the policy outlook back in March, BoC Deputy Governor Toni Gravelle noted that the Governing Council was evaluating how the process of adjusting asset purchases could unfold. "Adjusting the pace of QE purchases won’t necessarily mean that we have changed our views about when we will need to start raising the policy interest rate,” Gravelle further added.

In the meantime, the latest macroeconomic data releases from Canada reaffirmed the robust economic recovery. The IHS Markit Manufacturing PMI in Canada rose to its highest level in 10 years at 58.5 in March and the Unemployment Rate fell to 7.5% from 8.2% in February with the Net Change in Employment arriving at +303.1K, compared to analysts’ estimate for an increase of 100K.

Currently, the BoC is purchasing $4 billion worth of government of Canada (GoC) bonds and experts see the bank reducing this amount to $3 billion following the April meeting. This decision wouldn’t come as a surprise and the CAD’s reaction is likely to be short-lived. However, investors will keep a close eye on the BoC’s future plans with regards to additional reductions. In case the bank hints that it will continue tapering before the end of the year, the loonie could continue to outperform its rivals.

On the other hand, the BoC could refrain from taking immediate action while providing guidance on QE exit. A dovish tone combined with a cautious outlook could trigger a significant reaction in the CAD. 

USD/CAD technical outlook

The USD/CAD pair continues to trade below the descending trend line coming from early February. Meanwhile, the Relative Strength Index (RSI) indicator on the daily chart is moving sideways around 50, suggesting that the pair is having a difficult time finding direction.

If USD/CAD manages to make a daily close above 1.2570/90 area, where the descending trend line, the 20-day SMA and the 50-day SMA form strong resistance, on the back of a dovish BoC surprise, it could target 1.2675 (100-day SMA) and 1.2740 (March 1 high).

On the other hand, strong support is located at 1.2500. The pair tested that level in the previous five trading days but failed to make a daily close there. As mentioned above, a clear BoC tightening path and a reduction in current GoC purchases could open the door for additional losses toward 1.2400 (psychological level) and 1.2365 (2-year low set on March 15).