Bank of Canada Rate Decision Preview: Hawkish hike to exacerbate the pain in USD/CAD

After recording a monthly loss in February, USD/CAD is on track to witness more declines in the lead-up to Wednesday’s Bank of Canada (BOC) interest rate decision. The central bank is widely expected to hike the overnight rate by 25 basis points (bps) to battle soaring inflation amidst tightening labor market conditions and the Russia-Ukraine war.

BOC: Hawkish hike holds the key

This Wednesday at 1500 GMT, the BOC is seen raising the benchmark interest rate to 0.50% from an all-time low of 0.25% for the first time since October 2018. There is no press conference to be held by Governor Tiff Macklem following the March meeting.

At its January meeting, the central bank disappointed hawks by leaving the key rate unchanged at 0.25% from the final decision of 2021, announced in December.  

The BOC, however, removed its exceptional forward guidance on its policy interest rate, citing that the overall economic slack from the coronavirus pandemic had now been absorbed.

Heading into the monetary policy meeting, the country’s consumer price inflation accelerated to 5.1% YoY in January from 4.8% in December, hitting the highest level since 1991. Meanwhile, Canada’s unemployment rate rose to 6.5% in January, the first increase in the jobless rate since April 2021, thanks to the shutdowns related to the Omicron variant.

The covid-led slack in the employment sector is likely to be recovered soon while the central bank remains determined to combat raging inflation amid soaring oil prices. Further, the BOC may not want to fall behind the US Federal Reserve (Fed) in the tightening cycle, given a 25 bps rate hike is cemented for the March 15-16 FOMC meeting.

As the BOC 25 bps rate lift-off is well discounted by the market, the focus will remain on any hawkish tilt in the forward guidance. Governor Tiff Macklem and Co. could hint at aggressive tightening plans instead of a gradual approach towards normalizing monetary policy.

USD/CAD: Probable scenarios 

With the attention turning towards Wednesday’s BOC policy decision, investors remain rather cautious amid the Russia-Ukraine war. Monday’s peace talks between the two warring nations failed to offer any comfort, as markets continue to remain jittery, leaving the G10 currencies choppy.

Against that backdrop, the Canadian dollar needs a hawkish rate hike decision, with the statement offering signals on a series of hikes coming up to extend the downtrend in USD/CAD towards the February low of 1.2636.

The Canadian dollar could be a ‘sell the fact’ trade should the BOC deliver the expected 25 bps lift-off without any substantial hawkish shift in the policy statement. In such a case, USD/CAD could stage a rebound towards the 1.2700-1.2750 levels.

Adding to it, if the risk-off flows remain at full steam and the US dollar broadly bid, then USD/CAD could show a limited reaction to a likely BOC hawkish hike outcome.