More Canadian Dollar Strength "Path of Least Resistance"

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The Canadian Dollar's path of least resistance is to go higher according to Toronto Dominion Bank (TD).

The bank's securities division has revised its stance on Canadian fixed income and exchange rates following a surprise decision by the Bank of Canada to raise interest rates a further 25 basis points in a move that brings to an end a pause in the hiking cycle.

The move prompted the Canadian Dollar to move higher as investors adjusted for a higher interest rate environment, a development that could attract the inflow of foreign investor capital into Canada which is a supportive development for Canadian Dollar value.

"The Bank of Canada surprised markets with a 25bp rate hike. While the market was pricing in around 50/50 chance of a hike, USDCAD needs to move lower to reprice and we continue to see a break below 1.33 as the path of least resistance," says a note from TD Securities released June 08.

The U.S. to Canadian Dollar exchange rate fell to a four-week low at 1.3320 in the hours following the Bank of Canada's decision that signalled further interest rate hikes cannot be ruled out.

The Pound to Canadian Dollar exchange rate meanwhile tested a new seven-week low on June 08 at 1.6611 in response to the developments.

"The statement was hawkish, with the Bank citing more persistent excess demand and rising concerns that inflation could get stuck materially above target," says TD Securities.

TD Securities says the policy statement left its guidance open-ended, with the Bank citing several factors they will continue to evaluate going forward including the evolution of excess demand.

"We do not believe 25bps will be enough to bring the economy back into balance and continue to look for another rate hike in July for a 5.00% terminal rate," say analysts at the Canadian lender.

In its statement, the Bank of Canada noted Canada's economy was stronger than expected in the first quarter of 2023, that "consumption growth was surprisingly strong and broad-based" ... "demand for services continued to rebound" ... "excess demand in the economy looks to be more persistent than anticipated."

These are all inflationary developments and the Bank believes it has a cure: higher interest rates.

Analysts at Canadian bank CIBC also say they are expecting further Canadian Dollar weakness as a consequence of the Bank of Canada's recent decision and guidance.

"For USD/CAD, the bias is to the downside but there’s still enough two-way risk from US CPI and the Fed next week that should keep spot levels above the 1.3300 area for now. However, a Fed pause would be the catalyst for an extension lower to the 1.3000 – 1.3220 range," says Bipan Rai, Head of North American FX research at CIBC.

A slide in USD/CAD to such an extend would imply further downside in GBP/CAD, assuming GBP/USD remains unchanged.

"We do see the Bank hiking rates again in the coming months," says Rai.