What besides rate-hike bets is driving the Canadian Dollar's rebound?

Market attention has shifted to the Canadian Dollar (CAD) as traders debate the Bank of Canada's (BoC) next policy decision. A rush to price in an interest rate hike at the forthcoming meeting has pushed USD/CAD to 1.4071, substantially below its 14 October high of 1.4300. MUFG expects the BoC to follow through, potentially adding a second hike in December. Taking the opposing view, Standard Chartered considers the market's tightening expectations excessive and forecasts an unchanged rate of 2.25% through end-2026. RBC's survey findings, meanwhile, help explain the hawkish shift in pricing: inflation expectations in Canada are climbing sharply as trade negotiations with the US break down. Whether the BoC endorses those rate-hike expectations will determine CAD's next move.

Standard Chartered: Are Markets Pricing In BoC Hikes That Are Not Needed?

Standard Chartered economist Dan Pan forecasts that the BoC will leave its policy rate at 2.25% through end-2026 and 2027, despite market pressure for an increase as soon as this month. He sees limited scope for inflationary pressures to broaden, given weak domestic demand, muted core inflation and a soft labour market. An interest rate move in October, in his assessment, would reflect "caution, not necessity," while the approximately 100bps of tightening embedded in market pricing lacks a strong growth catalyst. He calls that pricing "excessive."

"We now expect the Bank of Canada (BoC) to stay put at 2.25% until end-2026 and 2027 (versus a cut in 2026 and a hike in 2027 previously). High oil prices have lowered the likelihood of a near-term rate cut, but sustained economic slack and contained underlying inflation still make a case for the BoC to look through near-term energy price shocks."

MUFG: Can Hawkish Repricing Sustain the Canadian Dollar's Recovery?

According to MUFG's Lee Hardman, the Canadian Dollar has extended its recovery against the US Dollar, taking USD/CAD to a low of 1.4071 and further away from the 14 October peak of 1.4300. Behind the move is a more hawkish assessment of the BoC's policy outlook. Interest rate markets now factor in around 21bps of hikes, compared with just 9bps at the end of last week, after three major Canadian banks all revised their forecasts to a hike at next week's meeting. Evidence from the BoC's business and consumer surveys adds support, with households reporting higher longer-term inflation expectations. However, September's heavy job losses, the second consecutive monthly decline, mean a hike is "not a done deal", Hardman acknowledges.

"The BoC has recently signalled that they are moving closer to hiking rates. If they place more weight on forward looking measures of inflation risks, and the Canadian rate market continues to price in a high probability of a hike heading into next week's meeting, we expect the BoC to pull the trigger and tighten policy."

RBC: How Is the Trade Talks Breakdown Lifting Canadian Inflation Expectations?

According to Claire Fan at Royal Bank of Canada (RBC), business sentiment in Canada strengthened through early August, only to deteriorate sharply following the collapse of Canada-US trade talks on 21 August. Alongside weaker sentiment, exports and investment, inflation expectations changed course. In September, firms' expectations for inflation one and two years ahead rebounded to 3.7% and 3.1%, respectively, close to their spring peaks. Half the firms surveyed intend to pass higher costs on to customers, a larger share than in the previous quarter. Consumers' longer-term expectations for inflation five years ahead also increased substantially, reaching the same level as shorter-term expectations, primarily because of the continuing Middle East conflict.

"Conditions among firms generally improved through early August, but evidence collected after the breakdown of Canada-U.S. trade talks on August 21 pointed to renewed weakness in sentiment, exports and investment alongside rising inflation expectations."

What Do the Banks' Differing Views Mean for the Canadian Dollar?

Despite assessing the same backdrop of higher inflation expectations, trade uncertainty and a fragile labour market, the three banks reach markedly different conclusions about the BoC's response and the implications for CAD. A hike next week is MUFG's expectation, with another increase possible before December, providing further support for the Canadian Dollar. Standard Chartered instead forecasts an unchanged rate of 2.25% through 2026 and 2027, arguing that markets have priced in excessive tightening. That view points to potential CAD vulnerability if rate-hike expectations unwind. RBC occupies the middle ground: its data highlights the inflation-expectations pressures underpinning the hawkish demand for CAD, while also revealing renewed real-economy weakness that makes the BoC's decision more difficult.

Will the BoC Validate the Market's Rate-Hike Bets?

The forthcoming BoC meeting will determine the Canadian Dollar's near-term course. Should the bank raise rates, as MUFG expects, the decision would likely confirm the market's repricing, prolong the decline in USD/CAD and encourage speculation about another increase in December. Alternatively, holding at 2.25% while looking through the energy-price shock, as Standard Chartered anticipates, could prompt an unwinding of hawkish positions and a retreat in CAD. In either scenario, RBC's findings suggest that the inflation-risk narrative is unlikely to dissipate soon: both firms and consumers are lifting their inflation expectations, and half of firms intend to pass on higher costs. That would maintain pressure on the BoC and leave CAD responsive to every indication of its next policy step.

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