Bank of Canada Preview: The end of the tightening cycle is around the corner

The Bank of Canada will have a monetary policy decision on Wednesday, December 7 and is widely anticipated to hike its benchmark rate by 50 bps from the current 3.75% to 4.25%. Although, as happens with other major economies, the aggressive tightening from 2022 to tame out-of-control inflation risks an economic setback. In such a scenario, there is a chance the bank will opt for a smaller hike of 25 bps and hint at a soon-to-come pause.

Where is Canada standing?

Inflation in Canada remains elevated, currently standing at 6.9% YoY. The annual Consumer Price Index peaked at 8.1% in June this year, and the latest figure suggests price pressures may have peaked. Nevertheless and according to local policymakers, "price pressures remain broadly based, with two-thirds of CPI components increasing more than 5% over the past year."

At the same time, the economy has shown firm signs of resilience. The third quarter Gross Domestic Product indicated an annualized growth of 2.9%, doubling expectations.

More relevantly, household spending has contracted by more than anticipated. Seen through inflation glasses is positive but clearly lifts the chances of a steeper economic setback. Finally, the job market remains tight. Plenty of available positions are still missing workers, which in the end, adds to inflationary pressures.

Bank of Canada decisions

Since March 2022, the central bank has hiked rates by 350 bps and is nearing restrictive rates. A potential 50 bps hike could be the last of the current cycle, while a 25 bps move could be followed by another one of the same extent before the central bank moves to the sidelines.  

Governor Tiff Macklem made it clear in October that the need to balance the risks of under and over-tightening monetary policy as the domestic economy starts fading.

USD/CAD levels to watch

The USD/CAD pair is up heading into the event, partially due to the broad US Dollar strength and partly due to falling oil prices. The fragile market sentiment may continue favoring the American currency in the upcoming sessions, with the pair set to continue rising.

The Canadian dollar could fall further if the central bank proceeds with a tepid hike while announcing it will be the last for the time being. On the other hand, a 50 bps move coupled with hints of at least one more hike in the docket could provide support to the CAD. Still, gains could be short-lived and quickly reversed.

From a technical point of view, the pair is bullish. The daily chart shows that it bounced sharply from the 61.8% retracement of its daily advance measured between 1.3224 and 1.3645 at around 1.3385 and is now poised to challenge the upper end of the range. A break through the latter should favor a continuation towards 1.3690 en route to 1.3807, November's monthly high.

A strong support level is the 38.2% retracement of the aforementioned rally at 1.3480, with a break below it exposing the next relevant Fibonacci support at 1.3385.