The BoC delivered a hawkish surprise at its last meeting. It increased rates by 50 bps as expected, but it increased the terminal rate to 2.5% from 2.25%. The BoC did this in order to show its growing worries about rising inflation. It announced the start of quantitative tightening too which is effective from April 25, but Governor Macklem said that the bank will not be yet actively selling bonds as part of the QT.

Governor Macklem on the interest rate level

BoC’s Governor Macklem stated in the press conference that the BoC may need to take rates modestly above the 2.5% neutral rate for a period of time. However, he also said that if inflation moderates then it could be appropriate to pause hikes once the BoC gets close to neutral. So, the BoC is setting up markets for a flexible and adaptable approach.

Inflation

Inflation data is key. The last Canadian inflation print came in very hot at 6.7% y/y vs the 5.7% prior reading, so that does keep the pressure on the BoC to hike rates. However, with short-term interest rate markets pricing in over 8 rate hikes this year, we could be near peak bullishness for the CAD. If you remember, in April 2021, October 2021, and January 2022 markets aggressively priced in CAD upside only to see it rapidly reverse. If we see the same response again the CAD could retrace heavily.

The takeaway

EURCAD longs potentially look attractive from here, but the technicals are tricky. If the ECB is forced to hike rates to deal with rising inflation in June or July then the Euro could make up some ground against the CAD. However, the risks are that the CAD strength continues, especially if oil markets show more strength on Russian/Ukraine risk. 1.3600 could be good for EURCAD longs as risk can be placed underneath 1.3500.