USD/CAD trades sideways below 1.4200 ahead of US inflation, BoC policy meeting

USD/CAD trades in a limited range ahead of the US inflation data release and the BoC policy announcement.
US core CPI is estimated to have grown steadily in November.
The BoC is expected to cut interest rates by 50 bps to 3.25%.

The USD/CAD pair consolidates in a tight range below the round-level resistance of 1.4200 in the European trading session on Wednesday. The Loonie pair trades sideways as investors await the United States (US) Consumer Price Index (CPI) data for November and the Bank of Canada’s (BoC) monetary policy decision, which are scheduled for the North American session.

Ahead of the US inflation data, the US Dollar (USD) revisits the weekly high after extending the winning streak for the fourth trading day, with the US Dollar Index (DXY) advancing to near 106.70. Market sentiment is slightly cautious as the inflation data would influence expectations for the Federal Reserve’s (Fed) likely interest rate action in the policy meeting on December 18.

Monthly and annual headline inflation are estimated to have grown by 0.3% and 2.7%, respectively, faster than their former readings. The core CPI – which excludes volatile food and energy prices – is expected to have risen steadily by 0.3% and 3.3% on month and annually, respectively.

Signs of a slowdown in inflationary pressures could boost dovish Fed bets. On the contrary, hot figures could weaken the same. According to a Reuters poll, 90% of economists expect that there will be a 25-basis points (bps) interest rate reduction by the Fed next week.

Meanwhile, the Canadian Dollar (CAD) will be influenced by the BoC’s policy meeting in which the central bank is expected to cut interest rates again by 50 bps to 3.25%. This would be the second consecutive outsize interest rate reduction by the BoC as it also cut its key borrowing rates by 50 bps in the October meeting and the fifth in a row. The BoC has already reduced its interest rates by 125 bps this year.

Canadian Dollar FAQs

What key factors drive the Canadian Dollar?

The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada’s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.

How do the decisions of the Bank of Canada impact the Canadian Dollar?

The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.

How does the price of Oil impact the Canadian Dollar?

The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canada’s biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.

How does inflation data impact the value of the Canadian Dollar?

While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian Dollar.

How does economic data influence the value of the Canadian Dollar?

Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.

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