Canadian Dollar "Ratcheting Lower" on Bank of Canada's Dovish Cut

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There was a definite CAD selloff in the wake of the Bank of Canada policy decision.

The Canadian Dollar dropped after the Bank of Canada lowered the policy rate by 25 basis points to 2.5%, bringing an end to a hiatus that saw it leave the rate at 2.75% for three consecutive meetings.

"With a weaker economy and less upside risk to inflation, Governing Council judged that a reduction in the policy rate was appropriate to better balance the risks," said the Bank in a statement.

The rate had been as high as 5% ahead of the commencement of the cutting cycle in June of 2024 and the market senses there's a good chance that we soon see a fall below the half-way mark to 2.25%.

This after the Bank said of inflation, "the upward momentum seen earlier this year has dissipated."

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i - Based on average GBP/CAD rate observed in July.

Expectations for further easing will weigh on the Canadian dollar which is testing multi-year lows against the euro and could soon print the lowest level against the pound since Brexit.

EUR/CAD trades at 1.6307, a level last seen in June 2009 while GBP/CAD trades at 1.8802, which puts it just below recent highs at 1.8803.

Against the U.S. Dollar, the Loonie is flat on the day at 1.3761, reflecting the ongoing pressure that it's southern neigbhour is under ahead of the Federal Reserve's interest rate cut due later in the day.

Governor Tiff Macklem more or less ratified bets for future cuts when he said a number of developments have shifted the balance of risks since the July decision:

First, Canada’s labour market has softened further.
Second, although there are still some mixed signals, on balance, recent data suggest the upward pressures on underlying inflation have diminished.
Third, with the removal of most retaliatory tariffs by Canada, there is less upside risk to future inflation.

Macklem also commented that the Bank will continue to look over a shorter horizon than usual, which tacitly opens the door toan October cut.

"We think this clears the way for another move at the Bank’s October meeting as officials lower borrowing rates into more clearly-accommodative territory," says Karl Schamotta, Chief FX Strategist at Corpay. "The Canadian dollar is ratcheting lower."

With the European Central Bank and the Bank of England likely to hold interest rates for the foreseeable future, the prospect of another Canadian rate cut will imply that pressures on CAD will remain most acute against the EUR and GBP.

"We expect CAD to continue to underperform peers in any USD selloffs as another BoC cut, the pending trade deal, and USMCA renegotiations prevent investors from turning too bullish in the short-term," says a note from Toronto Dominion Bank.

TD forecasts one additional 25bp cut in October; "given the clear consensus within Governing Council around the deteriorating outlook, we see a very high bar to pause next month."

Interestingly, money markets are not quite fully priced for an October move, with around 14bp of easing priced into the forwards market.

Given that current levels in the Canadian Dollar will reflect this, there would be scope for further weakness as the gap closes from 14bp to 25bp by the October meeting.

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