Canadian Dollar: BoC Expected to Cut 50bp - Can the Loonie Hold Its Ground?

The Bank of Canada is widely expected to lower the benchmark interest rate by another 50bp to 2.00% following the unexpected rate cut on October 8th. The coordinated rate cut initiated by the FOMC earlier this month paired with the downturn in the financial market has certainly increased speculation that Governor Mark Carney will ease policy further as fears of a global recession intensify.

Trading the News: Bank of Canada Rate Decision

What’s Expected

Time of release:                  10/21/2008 13:00 GMT, 09:00 EST

Primary Pair Impact :          USDCAD

Expected:                              2.00%

Previous:                               2.50%

Impact of the Bank of Canada Rate Decision on USDCAD over the last Three Meetings

September 2008 Bank of Canada Rate Decision

The BoC held continued to hold the benchmark interest rate steady at 3.00% for the third straight meeting, stating that borrowing costs are ‘appropriately accommodative.’ Despite the neutral policy stance taken on by the central bank, economic activity has clearly deteriorated throughout the first half of the year as the economy grew at an annual pace of only 0.3% in the second quarter. Meanwhile, the inflation rate jumped to 3.4% in July, climbing above the bank’s 3% limit for the first time since 2003. The Bank of Canada noted that they expect inflation to moderate next year, and went onto say that the deprecation in the Canadian dollar should help to support economic growth going forward.

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July 2008 Bank of Canada Rate Decision

As expected, the Bank of Canada continued to hold a neutral policy stance for the second consecutive month to keep the overnight borrowing costs steady at 3.00%. Despite increased price pressures, the downturn in the U.S. economy has certainly curbed growth prospects for Canada as the world’s largest economy consumes nearly 80% of Canadian exports. The slowdown in the U.S. paired with rising commodity prices have certainly made it increasingly difficult for the central bank to uphold their dual mandate to ensure price stability while supporting economic growth, and the BoC could be force to sit on the sidelines as higher food and oil prices continues to pose a threat on the economy.

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June  2008 Bank of Canada Rate Decision

The Bank of Canada held the benchmark interest rate steady at 3.00% despite expectations for a 25bp rate cut. Governor Mark Carney held a neutral policy stance for the first time this year to end the string of rate cuts that began in December, stating that upside inflationary risks have increased substantially on the back of rising energy costs. Policy makers noted that commodity prices are ‘sharply higher than expected’, and threatens to push inflation above the central bank’s upper limit of 3%. The BoC has joined its counterparts in the U.S. and the U.K. to keep the interest rate on hold to counteract the repercussion effects of rising food and energy costs, and acknowledged that the current stance taken on by the bank is ‘appropriately accommodative’ to achieve the bank’s 2% target for inflation.

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How To Trade This Event Risk

The Bank of Canada is widely expected to lower the benchmark interest rate by another 50bp to 2.00% following the unexpected rate cut on October 8th. The coordinated rate cut initiated by the FOMC earlier this month paired with the downturn in the financial market has certainly increased speculation that Governor Mark Carney will ease policy further as fears of a global recession intensify. In fact, growth concerns for the BoC have clearly increased as the U.S. economy, who consumes nearly 80% of Canadian exports, may have slipped into a recession in the third quarter, while the lack of stability in the credit sector continues to limit economic activity across the globe. The downturn in the world’s largest economy paired with the dovish policy stance taken on by the Fed have spurred bets that the Governor Carney will likely follow his counterpart and focused on growth as upside inflation risks diminish. Indeed, the BoC has been proactive in carrying out the dual mandate to ensure price stability while supporting economic activity, and the central bank is likely to take a preemptive approach to avoid slipping into a recession like its biggest trading partner to the south. Meanwhile, the dovish outlook taken on by Governor Carney and by Fed Chairman Bernanke suggests that the bank will continue to lower borrowing costs in the near-term, which could drag on the Canadian dollar going forward.

Despite the dour outlook for growth, inflation remains well above the BoC’s 3% limit, which could lead the central bank to refrain from delivering a 50bp cut this time around. In fact, the consumer price index increased to 3.5% in August to hold above the bank’s upper limit for the third consecutive month, and as upside prices pressures continues to pose a threat to the economy, the Bank of Canada may look to hold the benchmark interest steady at 2.50% or deliver a 25bp. Therefore, if the bank fails to lower the benchmark interest rate to 2.00%, we will look for a red, five-minute candle following the release to confirm a short trade on two lots of USDCAD. We will place our initial stop at the nearby swing low (or reasonable distance), and our first target will equal this risk. Our second target will be base on discretion, and in order to preserve our profits, we will move the stop to breakeven once the first trade reaches its target.

On the other hand, earlier this month we saw the USDCAD surge to a high of 1.2128 on 10/10, and another 50bp cut may only fuel bearish sentiment for the loonie. As a result, we will follow the same strategy for a long trade as the short mentioned above, just in reverse.