Canadian Dollar Outlook: BofA Backs a BoC Hold Despite Hike Expectations
The Canadian Dollar faces a test as BofA expects the Bank of Canada to hold rates, arguing weak activity limits the case for sustained tightening.
The US Dollar-to-Canadian Dollar exchange rate was trading at 1.4058 on Wednesday, extending Tuesday’s rise as investors awaited a Bank of Canada decision that BofA regards as much less straightforward than expectations of a hike suggest.
Dollar to Canadian Dollar (USD/CAD): 1.40382 (-0.09%)
Euro to Canadian Dollar (EUR/CAD): 1.563572 (-0.01%)
The bank expects the policy rate to remain at 2.25% on 28 October, with weak employment and subdued underlying inflation outweighing the pressure to act against higher energy costs.
Even if policymakers raise rates, BofA doubts that Canada’s economy can sustain the prolonged tightening markets have anticipated.
That separates its position from CIBC’s switch to an October hike call, which followed Governor Tiff Macklem’s communication despite the bank’s reservations about the economic case.
Weak employment complicates the inflation response
BofA’s Katie Craig and Carlos Capistran describe their hold forecast as a close call.
“We expect the BoC to leave its policy rate unchanged at 2.25%, although it is a close call, as we think weak economic activity and core inflation below target will ultimately favor a hold, while headline inflation above 3%, persistently high oil prices, and rising inflation expectations leave meaningful upside risks and would likely make any hold a hawkish one.”
Canada lost approximately 68,000 jobs in September, while unemployment rose to 6.5%.
The official employment figures show that the decline was concentrated in the public sector, with private-sector employment little changed.
That qualification matters for the scale of the slowdown, but the figures still offer little evidence of employers competing aggressively for scarce workers.
BofA highlights an average reading of 1.9% across the BoC’s core measures, below the 2% target, even as headline inflation has moved above 3%.
The September CPI release attributed the acceleration to 3.1% largely to gasoline, while inflation excluding gasoline slowed.
Raising borrowing costs cannot directly reverse an oil-price shock, but it can restrain spending and prevent businesses and households from treating higher inflation as permanent.
BofA sees that second risk as the strongest challenge to its forecast.
Craig and Capistran write: “The Consumer Expectations Survey adds an important upside risk to the outlook, with longer-term inflation expectations rising to match elevated shorter-term expectations.”
“This could make the BoC less willing to look through the inflationary impact of the current supply shock if expectations continue to rise.”
The bank also sees trade uncertainty constraining activity, making a rate increase harder to justify solely on the strength of headline inflation.
The analysts write: “At the same time, trade uncertainty remains elevated and is unlikely to dissipate soon, with no trade deal between the US and Canada expected before the mid-term elections.”
“In our view, this uncertainty will continue to weigh on the outlook and remains an important counterweight to the case for tightening.”
A hold could still carry a warning about December
For currency markets, the policy rate alone may therefore give an incomplete reading of the decision and accompanying Monetary Policy Report.
“Either outcome likely comes with hawkish communication and a move higher in Dec hike pricing. A surprise hold could trigger a sharp but short-lived rates rally, with the press conference likely to be hawkish.”
That anticipated rally refers to bonds, whose yields fall as prices rise.
For USD/CAD, an initial decline in Canadian yields could weaken the Canadian Dollar, but a subsequent warning that tightening remains likely could reverse part of that response.
BofA’s broader assessment also puts a limit on the support a hike might provide.
“The market is overpricing how much BoC can hike given ongoing weak activity and contained core inflation. Meanwhile, sticky high inflation and a robust consumer point to upside risk to rates in the US.”
The contrast leaves the Canadian Dollar exposed to the relative policy outlook even if Wednesday delivers a higher domestic interest rate.
What This Means for USD/CAD
A hold would leave the Canadian Dollar vulnerable if investors respond by removing expected tightening. The risk to that reaction is a press conference that makes a December move appear more likely, rather than signalling that the inflation concern has passed.
A hike could offer firmer immediate support, although BofA cautions: “We would see a hike as the start of a small adjustment-2 total hikes-not a full hiking cycle.” Guidance consistent with that view would give buyers less reason to expect a lasting improvement in Canada’s relative rate appeal.
BofA’s warning that sticky US inflation and resilient consumption could lift US rates points to a competing source of support for USD/CAD, even if the BoC chooses to act.
