Canadian Dollar: BoC inflation focus and valuation divergence – MUFG

Derek Halpenny at MUFG notes the Canadian Dollar’s (CAD) immediate advance after the Bank of Canada left rates unchanged at 2.25% but signalled greater concern over inflation. Communications hinted at a possible earlier hike, yet MUFG doubts a sustained CAD rebound, citing short‑term valuation models that suggest USD/CAD should trade higher, with Oil and Middle East risks also shaping CAD performance.

CAD reaction to BoC and Oil

"The Canadian dollar advanced immediately yesterday in response to the decision of the Bank of Canada to leave its monetary stance unchanged at 2.25% with the rhetoric accompanying the decision indicating a greater concern over the inflation outlook than market participants were expecting."

"However, the communications were certainly indicative of a possible rate hike coming much sooner. The reference to the policy stance being appropriate to achieving the inflation goal was omitted and the emphasis certainly shifted more to the upside inflation risks. Even with underlying inflation well contained there was a “heightened risk” that energy prices would spill over into broader measures of inflation."

"In the press conference the impact of tariffs on the economy was certainly the focus from a growth risk perspective but Governor Macklem added that the tariffs were applied to a ‘relatively narrow base’ and because of that the BoC did not expect a ‘big ongoing impact on overall economic activity’.”

"Our short-term valuation model for USD/CAD points to the USD/CAD level currently undershooting which is similar to the current divergence on the co-movement between USD/CAD and the 2-year swap spread. Both indicate USD/CAD should be trading between 1.40-1.41."

“That CAD upside risk related to oil is now more relevant given it also now appears to up the prospect of a BoC rate hike and that will help strengthen the CAD/Oil correlation given it’s now more closely associated to the BoC’s reaction function.”

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)