Breaking: BoC hikes interest rate to 4.75% vs 4.5% expected

The Bank of Canada (BoC) announced on Wednesday that it raised the benchmark interest rate by 25 basis points (bps) to 4.75% following the June policy meeting. This decision came in higher than the market expectation of 4.5%.

In its policy statement, the BoC said that concerns have increased that Consumer Price Index (CPI) inflation could get stuck materially above the 2% target. On a dovish note, the BoC removed the April language about how the bank is prepared to raise rates further if needed.

Although the BoC further noted that it continues to expect CPI inflation to ease to around 3% in the summer, it dropped the reference to inflation gradually falling to 2% target by end-2024.

Market reaction

With the initial reaction, USD/CAD came under heavy bearish pressure and dropped to a fresh monthly low of 1.3320 before staging a rebound beyond 1.3350.

Commenting on the BoC's policy announcements, "with BoC Governor Tiff Macklem’s “accumulation of evidence” criteria having been met, Governing Council determined monetary policy was not sufficiently restrictive to return inflation sustainably to target," noted Analysts at RBC Economics Research. "The concluding statement doesn’t include a clear tightening bias but our expectation has been that if the BoC was coming off the sidelines, they would intend to hike more than once—if 4.50% wasn’t restrictive enough it’s hard to think 4.75% is."

Key takeaways from the policy statement

"Excess demand in the economy looks to be more persistent than anticipated."

"Underlying inflation remains stubbornly high globally, major central banks are signalling that rates might have to rise further to restore price stability."

"Will continue evaluating whether evolution of excess demand, inflation expectations, wage growth and corporate pricing behavior are consistent with achieving inflation target."

"Canada's economy was stronger than expected in the first quarter, consumption growth was surprisingly strong and broad-based."

"Canadian housing activity has picked up, the labor market remains tight."

"BoC remains resolute in commitment to restoring price stability."

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• Bank of Canada is likely to maintain key interest rates at 4.5% on Wednesday.
• BoC was the first major central bank to pause its interest-rate hiking cycle in March.
• Canadian Dollar is set for volatility on the BoC’s rate outlook.

The Bank of Canada (BoC) is expected to keep interest rates unchanged at 4.5% for the third meeting in a row on Wednesday after becoming the first major central bank to hit the pause button in March. USD/CAD struggles in two-week lows, just above 1.3400, ahead of the BoC policy announcements as the Canadian Dollar continues to draw support from increasing Oil prices.

Strong economic performance in Canada has also underpinned the Canadian Dollar at the expense of the USD/CAD pair. Canadian Gross Domestic Product (GDP) expanded 0.8% QoQ after showing no change in the previous quarter, recording the fastest pace since the second quarter of 2022. Canada's real GDP grew at an annualized rate of 3.1% in the first quarter, following the 0.1% contraction in Q4 2022 and beating the market expectation for an expansion of 2.5%.

Meanwhile, Canada's inflation unexpectedly rose in April, picking up for the first time in 10 months. The country’s annual Consumer Price Index (CPI) rose 4.4% in April, compared with a 4.3% increase in March. On a monthly basis, the CPI was up 0.7% in April, following a 0.5% gain in March.

Bank of Canada interest rate expectations: Steady monetary policy for a while

The acceleration in Canada’s headline consumer inflation, combined with a resilient Canadian economy, exerts pressure on the central bank to bring rate hikes back on the table. However, the Bank of Canada is widely expected to hold rates steady at 4.5% at its monetary policy meeting on Wednesday, with markets pricing about a 60% probability of such a move.

Some industry experts and banks are revising their calls, expecting the BoC to deliver 50 bps rate hikes by September, while others are predicting the central bank to resume its tightening cycle in September. Markets are looking forward to Friday’s May employment report from Canada to reprice rate hike expectations in the second half of this year. Canada added a higher-than-expected 41,000 jobs in April while the Unemployment Rate remained steady at 5%, near the record low of 4.9% seen in June and July 2022. 

Analysts at TD Securities (TDS) offered a more hawkish outlook on the BoC policy decision this Wednesday. “We look for the BoC to hike by 25bp in June, and 25bp in July. Ongoing economic resilience will lengthen the path back to 2.0% inflation and as such, we believe the BoC needs to tighten further," they said.

"We were in the red zone for risks to further hikes, and this has pushed us to call for an additional 50bps of hikes (June, July) from here to bring us to 5% on the overnight rate. While market pricing is around 40% chance of a June hike, the reasons we are calling for a hike coupled with the market building towards a hike possibility are exactly why we continue to feel flatteners are the right way to skew,” TDS Analysts added.

When will the BoC release its monetary policy decision and how could it affect USD/CAD?

The Bank of Canada will announce its policy decision at 14:00 GMT. The policy announcements will not be accompanied by the central bank’s updated forecasts. There is no press conference to be held by Governor Tiff Macklem following the rates decision.

Should the BoC maintain rates at 4.5% but hint at a 25 basis points (bps) rate increase in July, the Canadian Dollar is expected to catch a fresh bid wave, hurting the USD/CAD pair. The major could also come under intense selling pressure if the central bank surprises with a 25 bps rate lift-off to 4.75%. The 1.3300 round figure could be then on USD/CAD sellers’ radars.

The Canadian Dollar could witness "sell the fact" trades in case the BoC holds rates and remains ambiguous about the future policy path. USD/CAD buyers are likely to recapture 1.3500 and beyond on a dovish hike.

Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for the USD/CAD: “The pair confirmed a Death Cross on the four-hour timeframe in Wednesday’s Asian trading after the bearish 50-Simple Moving Average (SMA) cut the flattish 200 SMA from above. This suggests that risks remain skewed to the downside for the USD/CAD pair, especially with the Relative Strength Index (RSI) also sitting way below the 50 level.”

Dhwani also outlines important technical levels to trade the major: “Sellers are likely to challenge the 1.3350 psychological level if USD/CAD sees a fresh leg lower in its ongoing downtrend. The next key support is seen at the May 10 low of 1.3335. Alternatively, immediate resistance awaits at the 21 SMA, pegged at 1.3424. Acceptance above the latter is critical to initiate a meaningful recovery toward the 1.3500 round figure.”