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Canadian Dollar Treads Water Ahead of BoC Rate Decision. How Will USD/CAD React?

Canadian Dollar Treads Water Ahead of BoC Rate Decision. How Will USD/CAD React?

Diego Colman, Market Analyst

The Bank of Canada's rate decision but, more importantly, its forward guidance could reinforce the medium-term bullish outlook for the Canadian dollar.

CANADIAN DOLLAR OUTLOOK:

  • The Bank of Canada will announce its March monetary policy decision tomorrow
  • Investors expect the central bank to raise the overnight rate by 25 basis points to 0.50% to tackle soaring inflationary pressures
  • The market has fully discounted a 25 basis point rate hike, so BoC’s forward guidance will be more important for USD/CAD price action

Most read: Oil Breaks Out to Fresh Highs as Commodities Remain Bid

USD/CAD is virtually flat on Tuesday, moving between small gains and losses around the 1.2700 psychological level amid market angst ahead of the Bank of Canada's monetary policy announcement due tomorrow. Investors expect policymakers to raise the overnight rate by 25 basis points to 0.50% to counter red-hot inflation, which reached a thirty-year high of 5.1% y/y in January, well above the target range of 1% to 3%.

The move has been discounted and is fully priced in the curve, so it will be a non-event in and of itself, so traders should focus on forward guidance and the overall tone to determine whether the tightening cycle will be aggressive or shallow this year.

BoC may appear somewhat cautious in light of the crisis between Russia and Ukraine, but the institution will not pivot or panic, as the ongoing military conflict is not expected to have a major effect on the global recovery. The bank is also likely to reiterate that economic slack has been absorbed and that the trajectory of consumer prices is skewed to the upside on account of supply chain snugs and rising energy costs, a message that could reinforce the case for a tighter policy stance. This scenario may cause the market to price in four additional hikes for 2022 with more conviction, which would be positive for the Canadian dollar.

While the Bank of Canada's rhetoric should bode well for the CAD, rising geopolitical tensions in Eastern Europe may limit its upside in the very near term. In general, when uncertainty is elevated and sentiment fragile, investors tend to flock to safe-haven assets, avoiding high-beta and riskier currencies that are prone to intense volatility.

However, over the medium term, the “loonie” maintains a constructive profile against the U.S. dollar. Strong Canadian employment growth, economic momentum, and improved terms of trade stemming from soaring oil prices are all bullish catalysts (terms of trade is the ratio of a country's export prices to import prices). That said, USD/CAD could trend steadily lower in the coming months once the mood becomes more upbeat and the broader market stabilizes following the invasion of Ukraine.

SD/CAD TECHNICAL ANALYSIS

After reaching a two-month high of 1.2878, USD/CAD has reversed lower, retreating towards its 50-day simple moving around the 1.2700 handle. If the pair manages to trade below this level decisively in the coming sessions, the next technical support lies at 1.2635 and then at 1.2600, the 38.2% Fibonacci retracement of last year's June/December rally. If these technical barriers are taken out, trendline support near 1.2550 will come into focus.

Alternatively, if buyers resurface and regain control of the market, resistance stands at 1.2878, last Thursday’s swing high. If the exchange rate climbs higher and breach this ceiling, bullish momentum could accelerate, setting the stage for a retest of this year’s high.

USD/CAD TECHNICAL CHART

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USD/CAD chart prepared using TradingView

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---Written by Diego Colman, Contributor

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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