On Wednesday, the Bank of Canada (BoC) will be in the spotlight as one of the initial G10 central banks to announce its rate decision this year. The general expectation is that the central bank will maintain the overnight rate target at 5% during this week's meeting, given indications of reflation in the recent Consumer Price Index (CPI) data.
Following the last central bank policy rate meeting, Canada's headline CPI rate accelerated to 3.4% year-on-year in December 2023, up from 3.1% in the preceding month. The increase in consumer prices was primarily attributed to a rebound in gasoline costs due to diminishing base effects. Inflation also rose for shelter, as elevated mortgage rates discouraged home ownership and pushed up rental prices. This aligns with the BoC's indication that headline inflation is anticipated to persist at a stubbornly elevated level, hovering close to the 3.5% mark through the middle of the year.
The rise in domestic CPI led to an increase in Canadian government benchmark bond yields across the yield curve. Specifically, the yield on the 10-year government bond reached a six-week high at 3.48%, driven by increasingly hawkish signals from BoC members. While policymakers express a readiness to "further raise the policy rate if necessary," we foresee limited prospects for additional policy tightening from this point onward. Tomorrow's rates decision is expected to be uneventful, with the BoC leaning towards a hawkish stance. We will closely monitor any additional guidance on the projected timeline for rate adjustments, which we believe are unlikely to occur before Q2.
Meanwhile, market expectations have shifted, with a 50.2% probability of a rate cut in the April meeting, a significant drop from around 80% just a week ago. Investors are reassessing the likelihood of an imminent BoC policy rate shift, providing temporary support for the Canadian dollar. Currently, the Canadian dollar is the best-performing major G-10 currency since last Friday, albeit with modest gains amid the prevailing strength of the US dollar. Looking ahead, we anticipate that the bullish momentum in USD/CAD, observed since December 27th, is losing steam, and we project a depreciation of the pair from its current levels. Any hawkish pushback from the BoC tomorrow could bolster the Canadian dollar and contribute to a retracement of the USD/CAD pair towards the $1.34 handle.
