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CAD looks primed for period of weakness on BoC inflation and interest rate outlook

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The Bank of Canada look to take their foot off the gas after today’s 25-basis point hike. With inflation expected to fall to 3% by mind-2023, could the CAD be due a period of downside?

bg%20canada_dollar_CAD_canadian_currencySource: Bloomberg

 Joshua Mahony | Senior Market Analyst, London | Publication date: Wednesday 25 January 2023 

Stocks rebound, as BoC lift hopes for a dovish pivot

The Bank of Canada has helped provide a boost for stocks, with the widely expected 25-basis point hike bringing an end to the tightening phase that has taken the benchmark overnight lending rate from 0.25% to 4.50% in just one-year. Crucially, this meeting brought the opportunity to signal that the BoC now plans to step aside and let those higher rates work their magic on prices. While inflation has managed to drop from a June peak of 8.1%, to the current 6.3%, there is confidence at the BoC that we will see Canadian prices back down to 3% by mid-2023. Meanwhile, the bank also predicts that the 2% target will be hit in 2024. This has obvious knock-on implications for interest rate expectations, although Governor Tiff Macklem has stated that it is too early to talk of cutting rates.

USDCAD technical analysis

The news that Canadian rates are set to flatline from here brings weakness for the Canadian dollar, with USDCAD rising as a result. Undoubtedly, we would be looking for further CAD weakness should inflation fall to the extent that the BoC explicitly states that they are looking at the possibility of cutting rates. Nonetheless, we are likely to see gains for this pair over the near-term too as traders wait and see if the FOMC take a similar stance. Looking at the daily chart, price has been finding support on the 76.4% Fibonacci support level, bringing about greater confidence that price will hold up once again. Down below, trendline support also brings another indicator to consider. With the wider trend of higher lows established here, it does look likely that price will turn upwards before long. A break below 1.3226 would be required to bring an end to this wider bullish trend.

USDCAD-Daily-2023_01_25-17h17.pngSource: ProRealTime

Another way of looking at this is through the CADJPY pair, with rising Japanese inflation bringing the potential for the Bank of Japan to tighten monetary policy just as the BoC take their foot off the gas. The daily chart highlights how that trend has been playing out of late, with further downside expected as a result. This pattern of lower highs and lower lows does provide the basis for a trade, with shorts preferred unless price rises back up through the latest swing-high of 0.9908.

CADJPY-Daily-2023_01_25-17h24.pngSource: ProRealTime
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