How the Bank of Canada's Decision Today Could Impact the Fed and the Dollar
Impact on GBP: Could Sterling's strength signal a pre-Brexit comeback?
GBP/EUR is approaching a key support level at €1.2195. If not for the strength of the Dollar, the Bank of England's trade-weighted Sterling index would likely be hitting new highs for the year. Two interconnected factors are driving Sterling’s momentum. First, a stable UK government paired with modest fiscal stimulus contrasts sharply with the ongoing political gridlock in parts of continental Europe. This divergence suggests UK growth is set to outpace the Eurozone next year. As a result, the Bank of England’s policy outlook is being aligned more closely with the Fed’s trajectory than the ECB’s. This alignment keeps Sterling hedging costs relatively elevated, with one-year EUR:GBP swap rate differentials holding steady at 200 basis points.
If GBP/EUR breaks above €1.2195, expect discussions of Sterling returning to pre-Brexit levels, possibly tied to improved relations between the new UK Labour government and the EU. While Sterling has room to perform well in the coming months (supported by the highest deposit rates in the G10), a potential risk lies in the Bank of England adopting a more dovish stance in February, especially as services inflation shows further significant declines.
For now, though, the focus remains squarely on the €1.2195 level in GBP/EUR.
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Impact on EUR: All eyes on ECB and US CPI for the next move
It’s been a quiet week on the European data front as investors await the week’s highlight: tomorrow’s ECB decision. Markets are pricing in a 25bp rate cut, which aligns with the view of ING. However, a dovish tone from President Lagarde during the press conference could keep the Euro under pressure. Rate differentials remain firmly in favour of the Dollar, but further widening would likely require a hawkish shift in the Fed’s outlook.
For EUR/USD today, attention will centre on the US CPI release and potentially the Bank of Canada’s decision. From a technical perspective, EUR/USD appears poised to resume its bearish trend, provided macroeconomic and geopolitical factors align. $1.0550/70 is today's key resistance level, with potential catalysts driving the pair toward the $1.0450 region.
Despite typically bullish seasonality for EUR/USD in December, the pair remains under pressure. Historically, January and February have been bearish months for the currency pair. Corporate America may welcome any EUR/USD rally, viewing it as an opportunity to reduce Euro exposure.
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No Major Data.
Impact on USD: Will the Dollar extend its rally?
The Dollar has regained strength, partly due to yesterday’s strong US NFIB Small Business Optimism Index, reflecting optimism around tax cuts and deregulation next year. Today’s focus is on the 13:30 GMT release of November US CPI. While the Fed may seem to have moved beyond the inflation story, a higher-than-expected core inflation print (forecasted at 0.3% m/m) could push the Dollar higher. Markets currently price an 88% chance of a 25bp Fed cut next week, but an upside surprise could shift those odds closer to 50:50.
The Bank of Canada (BoC) decision today may also offer clues. Two-thirds of surveyed economists expect a 50bp rate cut, aligning with New Zealand’s recent moves, while markets price in 44bp of cuts. If the BoC cuts by 50bp, widening the Fed-BoC rate spread to 150bp, it could suggest confidence in a 25bp Fed cut next week, weakening CAD and slightly softening the Dollar.
If the BoC opts for only a 25bp cut, it may indicate doubts about a Fed move next week, as leaving the Fed-BoC spread at 150bp (BoC at 3.25%, Fed at 4.75%) would likely push USD/CAD toward CA$1.4300. In this case, the USD could strengthen on the view that next week’s FOMC decision remains uncertain.
Major Data:
13:30 - Core CPI m/m, CPI m/m & CPI y/y
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