The Bank of Canada (BoC) has decided to keep its policy rate at 2.25%, which many in the market expected. Governor Tiff Macklem noted that although the economy has more supply than demand, growth is likely to remain slow. Recent data showed a strong third quarter, mostly due to low imports, but a weaker fourth quarter is expected. Inflation is close to the 2% target, while core inflation is around 2.5%. Following the BoC’s announcement, the Canadian Dollar lost value against several major currencies, trading near 1.3860 against the USD. The BoC’s aim is to support the economy amid trade tensions while managing inflation. Looking ahead, a small rate increase is expected by 2026, indicating that the bank is comfortable with the current rates. The BoC’s past measures, including quantitative easing and interest rate management, are intended to stabilize the economy during difficult times. Globally, changes in interest rates can greatly impact currencies. Higher rates often strengthen a currency, while lower rates can reduce inflation. These considerations are key to the BoC’s policy-making. Given the Bank of Canada’s cautious approach, we expect the Canadian dollar to weaken in the coming weeks. The governor has been downplaying strong data and highlighting that the economy has too much slack. This implies that the central bank is not in a hurry to raise interest rates and is willing to let the economy grow at its own pace. Recent data supports this weak outlook. The November jobs report, released on December 5, showed the unemployment rate rising to 6.2%, indicating stalled hiring plans. Additionally, retail sales in October fell by 0.2%, confirming that domestic demand is flat, which aligns with the bank’s assessment. As a result, the USD/CAD pair moved toward 1.3860, and this trend is likely to continue. With the BoC taking a pause and expressing concerns about growth, the Canadian dollar may weaken further. We see the next target as the 200-day moving average around 1.3904, which might serve as a significant resistance level. Moreover, the Canadian dollar is facing downward pressure from falling energy prices. The price of WTI crude oil has decreased to below $78 a barrel, down from its November highs. Generally, a drop in oil prices negatively impacts the Canadian economy and its currency. In contrast, the United States is seeing the Federal Reserve maintain its current stance without indicating any upcoming cuts. This difference in policy—between a cautious BoC and a steady Fed—usually benefits a stronger U.S. dollar. We believe this divergence will significantly influence the USD/CAD exchange rate as we head into the new year. For derivative traders, this situation suggests buying call options on the USD/CAD to take advantage of potential gains with limited risk. As the currency pair approaches key technical levels, implied volatility may increase. This strategy allows us to profit if the Canadian dollar weakens, as we expect over the next few weeks. We will keep a close eye on Canada’s upcoming November Consumer Price Index (CPI) report, set to be released on December 18. If inflation readings are low, it would support the BoC’s cautious stance and likely lead to further declines in the Canadian dollar. However, if inflation surprises on the upside, it could challenge this outlook.

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