Bank of Canada Governor Tiff Macklem plans to hold a news conference after delivering a third consecutive 25 basis point interest rate cut.

Key conclusions

Inflation could rise in behind schedule 2024; there is a risk that inflationary factors may be stronger than expected.

The overall weakness of the Canadian economy continues to push inflation down.

The latest data suggests the bank’s July forecasts of stronger growth in the second half of 2024 are subject to some downside risk.

We need to increasingly protect ourselves against the risk that the economy will be too delicate and inflation will fall too far.

If inflation continues to decline, in line with our July forecast, further interest rate cuts can be expected.

There was a robust consensus for a 25 basis point rate cut.

We discussed various scenarios, including a slowdown in the pace of interest rate cuts as well as a 50 basis point cut.

At that point, a 25 basis point cut seemed appropriate.

In one scenario, if the economy turns out to be weaker than expected, it would be appropriate to cut interest rates by more than 25 basis points.

There is no apparent major impact of interest rate divergence with the US Federal Reserve on the exchange rate.

We must get Canada’s economy above 2% and factor the need for greater growth into our policy decisions.

House price inflation remains too high.

The following section was published following the Bank of Canada’s (BoC) interest rate decision at 13:45 GMT

The Bank of Canada cut its key interest rate by 25 basis points to 4.25% on Wednesday, in line with expectations, while signaling concerns that weaker-than-expected economic growth could lead to a bigger drop in inflation.

Governor Macklem noted in his opening remarks that as inflation approaches its target, the Bank must be increasingly cautious to prevent inflation from falling too much as a result of the economy weakening too much.

He stressed that the central bank is equally concerned about inflation falling below the target as it is about it rising above the target.

Macklem noted that overall economic weakness is pushing inflation lower, while persistent price pressures in housing and some services are keeping inflation high.

He said that if inflation continues to decline, in line with the Bank of Canada’s July forecast, further interest rate cuts could be expected.

Market reaction

The USD/CAD pair is trading higher and lower, holding around 1.3540 – slightly lower than the previous weekly highs of 1.3565-1.3570.

The following section was published as a preview of the Bank of Canada’s (BoC) interest rate decision at 08:00 GMT

• The Bank of Canada (BoC) is expected to cut its interest rate to 4.25%.
• The Canadian dollar started the month worse than the US dollar.
• Core inflation in Canada fell even further in July.
• In swap markets, easing of around 36 basis points is expected this week.

The Bank of Canada (BoC) is widely expected to cut its interest rate for a third consecutive time at its September 4 meeting. Like the central bank’s previous decisions, the move is likely to be 25 basis points, taking the benchmark rate to 4.25%.

Since the beginning of the year, the Canadian dollar (CAD) has weakened against the U.S. dollar (USD), which resulted in the USD/CAD rate reaching recent highs near 1.3950 in early August. Since then, however, the Canadian currency has embarked on a period of rapid appreciation, dragging the pair down about 5 cents by the end of last month.

In July, the annual rate of national inflation, as measured by the headline Consumer Price Index (CPI), fell further to 2.5% compared with the same month in 2023, while the BoC’s core CPI fell below its 2.0% target, having risen 1.7% over the past twelve months. The expected rate cut by the central bank appears to be linked to the ongoing decline in consumer prices and the anticipated further easing in the Canadian labor market.

Inflation has been below 3% since January, in line with the central bank’s forecast for the first half of 2024, and key core consumer price indicators are also showing a steady decline. In addition, the BoC is likely to continue to base its future interest rate decisions on economic data. Current swap markets suggest around 36 basis points of easing in September.

The Bank of Canada could maintain its dovish narrative

Despite the expected interest rate cut, the central bank’s overall stance is expected to be rather cynical, especially in the face of falling inflation (suggesting that the headline CPI may soon reach the bank’s target level) and growing slack in the labor market.

After cutting interest rates in July, BoC Governor Tiff Macklem argued that the economy was experiencing excess supply and that slack in the labor market was contributing to downward pressure on inflation. He explained that their assessment indicated that there was already enough excess supply in the economy and that the necessary conditions were increasingly present to bring inflation back to the 2% target. He also emphasized that rather than needing more excess supply, there was a need for economic growth and job creation to get going to absorb the excess supply and achieve a sustainable return to the inflation target.

Macklem added that the central bank aims to balance risks on both sides, expressing a determination to bring inflation down to 2% without overly weakening the economy and causing inflation to fall below target. He noted that these considerations will be carefully considered in the future, with decisions made at each meeting.

In lightweight of the upcoming BoC interest rate decision, Taylor Schleich and Warren Lovely of the National Bank of Canada said:

“The Bank of Canada is set to cut its overnight rate target by 25 basis points on Wednesday, its third such move in as many meetings. The one data point that could have thwarted the cut — the July CPI report — provided encouraging news on core inflation, allowing policymakers to ease policy without controversy.

“Meanwhile, although the July jobs report revealed an unchanged unemployment rate, the labor market outlook remains challenging. Consensus expectations for the unemployment rate (and those implied by the Bank of Canada’s rosy growth forecasts) are overly optimistic, and we continue to forecast the unemployment rate to reach ~7% by year-end.”

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

The Bank of Canada will announce its monetary policy decision on Wednesday, September 4 at 13:45 GMT, followed by a press conference by Governor Macklem at 14:30 GMT.

Eliminating any potential surprises, the impact on the Canadian currency is expected to come primarily from the bank’s statement rather than the rate move itself. A conservative approach could result in more support for CAD and a subsequent decline in USD/CAD. If the bank indicates it intends to continue to lower rates, the Canadian dollar could suffer and open the door to further gains in USD/CAD.

According to Pablo Piovano, Senior Analyst at FXStreet.com, “USD/CAD has been on a robust downtrend since early August, reaching monthly lows near 1.3640 last week. The rebound since then has been largely driven by a rebound in the US dollar (USD), prompting the pair to reclaim the 1.3500 barrier and break through it so far.

Pablo adds:

“The immediate target comes in at the 200-day SMA, currently at 1.3589. Once this region is cleared, the pair could revisit the 1.3665-1.3680 range, where the interim 55-day and 100-day SMAs converge. There is no resistance level worth considering beyond the 2024 high at 1.3946 on August 6.

“If bears regain the initiative, USD/CAD could revisit the August low of 1.3436 (August 28) before the March low of 1.3419 (March 8). A deeper decline beyond the latter exposes a move to the December 2023 low of 1.3177 (December 27),” Pablo concludes.