Risks asymmetrically skewed towards CAD upside
July 23 (Reuters) -The Bank of Canada is widely expected to cut rates for a second consecutive meeting on Wednesday, with market pricing implying that a rate cut is a done deal, attaching a 92% probability (23bps).
However, the recent move higher in underlying inflation would suggest that the risk of a hold is higher than what is currently embedded in markets.
Since the BoC delivered its first cut in June, the bank’s preferred measure of core inflation – three-month annualised median and trimmed CPI – has risen from 1.5-1.7% to 2.9%.
In turn, policymakers may opt to wait for more inflation data and thus rate action until September, after the next CPI print due on August 20, to gauge whether the recent move is the beginning of a trend higher or a short-term blip.
On the flipside, the labour market has softened, as highlighted by the notable pick-up in the unemployment rate, now at 6.4% and the highest since January 2022, which does support the case for back-to-back rate cuts.
For the Canadian dollar, the risk-reward is skewed to the upside. A rate cut is near fully priced in and speculative net shorts in CAD are not far off a record high. Therefore, the currency impact from a BoC cut is likely to be limited.
Keep in mind that USD/CAD is nearing key hurdles that have kept a lid on the pair over the last two years.
While a surprise hold would clearly lead to a bullish CAD reaction, so would a rate cut that is accompanied with a cautious policy statement following the recent move higher in underlying inflation.
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Canadian CPI underlying https://tmsnrt.rs/3WlJu0K
(Justin McQueen is a Reuters market analyst. The views expressed are his own.)
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