A Crunch Week For Central Banks: Policy Statements May Surprise The Market

Key Takeaways

• Investors and traders will finally get some fresh clues on the future path of interest rates in two major economies— Canada, and the Eurozone.
• All two central banks are expected to keep the rates steady but will likely announce important changes in their monetary policy statements.
• Some central bank statements—if not all—will likely surprise the markets.
• The doves hoping for early interest rate cuts may be disappointed.
• Market expectations are currently skewed to the dovish side, so any hawkish remarks on the part of central bankers will no doubt provoke above-normal volatility in the forex market.

Relative monetary policy drives currencies’ exchange rates. Therefore, traders concentrate and take notes whenever a major central bank is due to announce its policy rate decision. Next week, two central banks—, the Bank of Canada (BoC), and the European Central Bank (ECB)—will declare their verdict on interest rates in the span of less than 72 hours.

Their decisions, announcements, and subsequent press conferences will be closely watched by traders and investors alike. Overall, the market assumes that the rate-hiking cycle is over and that global central banks will embark on an aggressive easing campaign this year. However, the most ardent doves are likely to be disappointed. Octa offers a brief overview of what to expect.

Bank of Canada

BoC’s rate decision will be announced at 3:00 p.m. UTC on 24 January. The market expects BoC to leave its overnight rate steady at 5%. However, the central bank is unlikely to sound dovish because inflation remains elevated due to high growth in Canadian wages and shelter costs. According to the official data, annual inflation in Canada rose to 3.4% in December from 3.1% in November, making investors scale back their expectations for an early interest rate cut. During the press conference, Governor Tiff Macklem will probably attempt to strike a cautiously hawkish balance, underlying inflation concerns and acknowledging an economic slowdown.

Overall, the BoC is probably the least dovish of the three central banks that will be updating their policy statements this week. A slower move to rate cuts could help support the Canadian dollar. Although USDCAD has recently rallied to a one-month high, it faces stiff resistance in the 1.35500-1.36000 area. Should BoC deliver a hawkish statement, the long-term bearish trend in USDCAD may resume, potentially targeting the 1.34000 level. As of right now, the market is pricing in roughly 100 basis points worth of rate cuts by the end of 2024, with the first cut widely anticipated in April.

European Central Bank

The ECB will issue its monetary policy updates at 1:15 p.m. UTC on 25 January. The majority of economists polled by Reuters expect the central bank to leave its refinancing rate at 4.50% and deposit rate at 4.0%. The signals from the ECB have been rather mixed lately. In fact, contradictory statements from the officials have made it more difficult for traders to assess the sentiment inside the ECB and project the future path of interest rates. As a result, investors’ interest rate expectations have been moving sharply in recent weeks, causing volatile price action in EUR pairs.

Overall, the ECB does not look like it is ready to deliver a rate cut. Headline inflation remains above the official 2.0% target, while tensions in the Red Sea have pushed cost inflation higher due to rising freight rates. The most likely scenario is for the ECB to leave its monetary policy unchanged and clarify its stance on future rate cuts. As of right now, the market is pricing in roughly 130 basis points worth of rate cuts by the end of 2024, with the first cut widely anticipated in either March or April. If, indeed, the ECB decides to cool off the investors and make them dial back their expectations for a rate cut, EURUSD may rally back above 1.09300.

About Octa

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