USD/CAD: Trading the Bank of Canada Interest Rate Decision

The Bank of Canada is widely expected to keep the benchmark interest rate at 1.00% in May, but a dovish policy statement is likely to spur a bearish reaction in the loonie as the central bank looks to carry its wait-and-see approach into the second-half of the year.

Trading the News: Bank of Canada Interest Rate Decision

What's Expected:

Time of release: 05/31/2011 13:00 GMT, 9:00 EST

Primary Pair Impact:USDCAD

Expected: 1.00%

Previous: 1.00%

DailyFX Forecast: 1.00%

Why Is This Event Important:

The Bank of Canada is widely expected to keep the benchmark interest rate at 1.00% in May, but a dovish policy statement is likely to spur a bearish reaction in the loonie as the central bank looks to carry its wait-and-see approach into the second-half of the year. According to Credit Suisse overnight index swaps, investors are now pricing borrowing costs in Canada to increase by 75bp over the next 12-months which compares with expectations for a 100bp worth of rate hikes from just earlier this month, and the Canadian dollar may face additional selling pressures heading into the June as interest rate expectations falter. In turn, the near-term rally in the USD/CAD may gather pace, and the exchange rate certainly looks poised to make a run at the 78.6% Fibonacci retracement from the 2007 low to the 2009 high around 0.9900-20 as central bank Governor Mark Carney maintains his pledge to ‘carefully consider' future rate hikes.

Recent Economic Developments

The Upside

Release	Expected	Actual
Leading Indicators (MoM) (APR)	0.6%	0.8%
International Merchandise Trade (MAR)	0.4B	0.6B
Net Change in Employment (APR)	20.0K	58.3K

The Downside

Release	Expected	Actual
Consumer Price Index (YoY) (APR)	3.4%	3.3%
Retail Sales (MAR)	0.9%	0.0%
Ivey Purchasing Manager Index s.a. (APR)	65.5	57.8

As the BoC sees the economic recovery in Canada gathering pace, the ongoing expansion in employment paired with the improvement in global trade may encourage the central bank to normalize monetary policy further in 2011. However, the central bank is widely expected to maintain its current policy given the slowdown in private sector consumption paired with the soft inflation report, and Governor Carney may look to support the real economy throughout the second-half of the year as growth and inflation cools. In turn, the USD/CAD appears as though it has carved out a major bottom in May, and the exchange rate should continue to trend higher over the near-term as long as we see the BoC talk down speculation for higher borrowing costs in Canada.

Potential Price Targets For The Rate Decision

How To Trade This Event Risk

Trading the given event risk is certainly not as clear cut as some of our previous trades, but hawkish comments following the rate decision could pave the way for a long Canadian dollar trade as market participants weigh the prospects for future policy. As a result, if the BoC continues to raise its outlook for the region and shows an increased willingness to lift the benchmark interest rate from 1.00% later this year, we will need to see a red, five-minute candle following the release to generate a sell entry on two-lots of USD/CAD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing low or a reasonable distance after taking market volatility into account, and this risk will establish our first target. The second target will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in an effort to lock-in our winning.

On the other hand, the ongoing weakness in the real economy paired with the slower-than-expected rate of inflation certainly backs the neutral policy stance held by the BoC, and the central bank may look to retain its current policy throughout the third-quarter as it aims to encourage a sustainable recovery. As a result, if the board keeps the interest rate at 1.00% and talks down speculation for higher borrowing costs, we will implement the same strategy for a long dollar-loonie trade as the short position laid out above, just in the opposite direction.

Impact that the Bank of Canada Interest Rate Decision has had on CAD during the last meeting

Period	Data Released	Estimate	Actual	Pips Change (1 Hour post event )	Pips Change (End of Day post event)
Apr 2011	4/12/2011 13:00 GMT	1.00%	1.00%	+37	+32

April 2011 Bank of Canada Interest Rate Decision

The Bank of Canada held the benchmark interest rate at 1.00% in April, and repeated that future rate hikes will be ‘carefully considered' as the fundamental outlook remains clouded with high uncertainty. Despite the dovish comments, the central bank noted that the economic recovery has been ‘stronger' an initially expected, and sees inflation averaging ‘around three percent' in the second-quarter, largely driven by ‘temporary factors.' Moreover, the BoC went onto say that the marked appreciation in the local currency could ‘create even greater headwinds for the Canadian economy,' and the central bank may carry its wait-and-see approach into the second-half of the year as it aims to encourage a sustainable recovery. Indeed, the Canadian dollar lose ground following the dovish rhetoric from the BoC, with the USD/CAD rallying to a high of 0.9654, but the loonie recoup some of the losses by the end of the day as the pair closed at 0.9610.

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To discuss this report contact David Song, Currency Analyst: dsong@dailyfx.com