PoundSterlingLIVE - The Canadian Dollar could find near-term support if the Bank of Canada errs on the 'hawkish' side next week by batting away expectations for interest rate cuts.
The Bank of Canada will strike a 'hawkish' tone at next week's policy update, according to an analysis from the Royal Bank of Canada (TSX:RY) (RBC).
Economists at RBC say although the Bank of Canada (BoC) slipped into a 'neutral' phase in December, it would not be downshifting to outright 'dovish' this January.
"Based on the recent data, particularly still elevated wage and inflation expectations... it is highly unlikely that the BoC shifts into the dovish spectrum," says Jason Daw, Economist at RBC's Dominion Securities division.
"Compared to the December meeting, there are more reasons to keep the phrase 'prepared to raise the policy rate further if needed' and err on the more hawkish side," he adds.
He cites recent data that points to still elevated wage and inflation expectations in the BoC/CSCE surveys, the sharp jump in three-month annualised core inflation trends, sticky actual wage growth and a plateau in the unemployment rate.
Should the 'hawkish' tilt come as a surprise to the market, the Canadian Dollar could find itself supported.
On Tuesday, it was reported that Canadian inflation accelerated in December, rising to 3.4% year-on-year in line with expectations, but still a 0.3pp increase on November’s 3.1% reading.
Of particular concern for the BoC, however, will be the increase in core inflation readings, with both core-trim and core-median inflation readings printing above expectations.
"Policymakers will likely point to this uptick as a basis for holding rates high for longer, posing a risk to our forecast for the BoC to ease in early 2024," says Nick Rees, FX Market Analyst at Monex Europe.
Markets will focus on the contents of the Monetary Policy Report, where new inflation forecasts are issued.
Downgrades are expected owing to falling global energy prices, but RBC says a risk to the 'hawkish' case would be Q4 2024 inflation forecast dipping below 2% or Q4 GDP growth being lowered closer to 0%.
RBC's market strategists are nevertheless positioned for risks to skew "to a less dovish outcome (statement/presser) than what the market is currently pricing, which would fuel the recent trend (bond yields higher and reductions in near-term rate cut pricing)."
The Canadian Dollar has benefited from these developments and is the fourth-best performing currency of 2024 in the G10 space.
This outperformance can extend into the month's end if the BoC strikes a 'hawkish' tone relative to market expectations.
An original version of this article can be viewed at Pound Sterling Live