Bank of Canada Rate Decision Preview: No surprises for a 25bps rate hike

USD/CAD is on a winning spree heading into Wednesday’s Bank of Canada (BOC) interest rate decision, the first for this year. The central bank is seen holding the overnight rate steady at 0.25%, although a surprise 25-basis points (bps) could not come as a surprise amid Canada’s multi-decade high inflation rate and robust labor market. 

BOC: To hike or not to hike?

The BOC is likely to leave the benchmark interest rate unchanged at an all-time low of 0.25% when it announces its policy decision this Wednesday at 1500 GMT. 

The central bank will publish its quarterly Monetary Policy Report (MPR) alongside the rate statement. Governor Tiff Macklem’s press conference will follow at 1615 GMT.

At its final meeting of 2021 in December, the BOC announced no changes to its monetary policy settings and said it doesn’t see a rate hike until mid-2022, warning that the Omicron coronavirus variant has created "renewed uncertainty." 

January’s policy announcements could see the BOC surprising markets with a 25-bps rate lift-off amid Canada’s solid economic performance over the last quarter.

Markets are now pricing in roughly 70% probability of a 25-bps rate hike at this meeting, especially after December’s inflation data reported a 30-year high inflation rate of 4.8%. Surging home prices remain a concern for the central bank, as it could act to contain soaring inflation. 

Meanwhile, the labor market in the North American economy remains tighter, overcoming the Delta and Omicron impact, prompting the central bank to hike rates sooner than later. Canada created another 54,000 jobs in December after adding 153,700 jobs in November. Meanwhile, the country’s unemployment rate dropped to 5.9% last month, approaching pre-pandemic levels of 5.6%. 

Another rationale that could lead the BOC to go ahead with a rate hike is that Ontario is set to ease the Omicron covid variant-led restrictions at the end of this month. 

Additionally, the BOC may not want to fall behind the US Federal Reserve (Fed) in the tightening cycle. The Fed is expected to hike rates by a quarter percentage point in March. Note that the Canadian central bank was the first central bank to signal a hawkish shift. 

USD/CAD: Probable scenarios 

USD/CAD is correcting from three-week highs of 1.2702, at the press. The US dollar strengthens further amid rebounding Treasury yields, as the Russia-Ukraine crisis-led risk-aversion cools off a bit this Tuesday. The renewed upside in oil prices is offering some support to CAD bulls in the lead-up to the BOC rate decision. The Fed is also set to announce its monetary policy decision on Wednesday. Therefore, the sentiment around the greenback and the yields will continue to dominate, limiting USD/CAD’s reaction to the BOC announcements. 

Technically, the latest corrective decline in USD/CAD that followed the recovery rally has taken the shape of a bull flag on the four-hour chart. The pair is primed for an upside breakout, according to the chart, suggesting that the BOC is unlikely to cheer the hawks while the Fed outcome could likely fan its aggressive tightening expectations. 

On the upside, acceptance above the falling trendline resistance at 1.2658 on a daily closing basis will refuel the upside potential. The next resistance awaits at the horizontal 200-Simple Moving Average (SMA) at 1.2707, above which the horizontal trendline at 1.2733 could be tested. The Relative Strength Index (RSI) holds comfortably above the midline, allowing room for more upside. On the flip side, strong support aligns at 1.2615, below which the bullish formation will get invalidated, opening floors towards the mildly bearish 100-SMA at 1.2601. The last line of defense for buyers is seen at 1.2560, the upward-pointing 21-SMA.