Canadian Dollar: BoC inflation focus and valuation divergence – MUFG
Derek Halpenny at MUFG notes the Canadian Dollar’s (CAD) immediate advance after the Bank of Canada left rates unchanged at 2.25% but signalled greater concern over inflation.
The Canadian Dollar (CAD) experienced an immediate rise following the Bank of Canada's decision to maintain interest rates at 2.25%, as communicated by Derek Halpenny at MUFG. However, the Bank's rhetoric surrounding the decision highlighted a heightened concern over inflation, which may prompt an earlier rate hike. This shift in focus from inflation risks to potential policy changes suggests a divergence in the valuation of CAD.
Despite underlying inflation being well contained, there is a heightened risk that escalating energy prices could influence broader inflation measures. The short-term valuation model for USD/CAD suggests that the exchange rate is currently undervalued, similar to the divergence between USD/CAD and the 2-year swap spread, which indicates a potential range of 1.40-1.41.
The CAD's upside risk, associated with oil prices, becomes more relevant as it may strengthen the CAD/Oil correlation due to the Bank of Canada's potential reaction to the situation.
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