In an otherwise relatively light week for global economic releases, the week ahead will be dominated by two major central bank decisions – the Bank of Canada (BoC) on Wednesday and the European Central Bank (ECB) on Thursday.
Clearly, the Canadian dollar and the euro will be the major currencies in focus as markets assess whether the BoC will continue its policy path to higher interest rates and if the ECB will provide concrete details on plans to taper its massive economic stimulus program. Neither central bank is expected to raise interest rates next week, but any indications as to how their policy paths may unfold in coming months will have substantial impacts on their respective currencies.
Bank of Canada
A surprisingly hawkish Bank of Canada raised interest rates back-to-back in July and September, helping to fuel and extend a Canadian dollar rally and USD/CAD downtrend within the third quarter of this year. Starting in early September, however, as the battered US dollar began to rebound from multi-year lows, the Canadian dollar lost ground against the greenback. The oversold US dollar was driven higher due in part to rising expectations of a Federal Reserve interest rate hike by the end of the year.
Recent signs have been pointing to the likelihood that the BoC may become more dovish going forward. Late last month, well after the September rate hike, Bank of Canada Governor Stephen Poloz stated in a speech that there would be “no predetermined path for interest rates,” and then went on to warn that “monetary policy will be particularly data-dependent in these circumstances and, as always, we could still be surprised in either direction.” Those comments appeared to back off from the central bank’s previously hawkish stance.
On Friday, key Canadian inflation and retail sales data were released that were significantly lower than expected. The monthly Consumer Price Index for September came in at +0.2% against a prior consensus forecast of +0.3%. In addition, both retail sales and core retail sales (excluding automobiles) for August were substantially negative against positive expectations. Retail sales came in at -0.3% versus +0.5% expected, while core retail sales suffered a sizable -0.7% loss versus +0.3% expected.
These weak inflation and retail sales numbers clearly do not bode well for further near-term policy tightening by the data-dependent BoC. As a result, Friday saw the Canadian dollar fall sharply, which was exacerbated by a US dollar surge. Pressure on the Canadian dollar is likely to continue if the BoC indeed strikes a dovish tone next week, and especially if the US dollar and hawkish Fed expectations both remain supported.
European Central Bank
The ECB policy decision and press conference are set for Thursday. Prior to the ECB meeting, key services and manufacturing PMI data for France, Germany, and the eurozone as a whole, will be released on Tuesday.
Although an interest rate increase is certainly not expected from the ECB next week, euro traders will be paying extremely close attention to any indications by ECB President Mario Draghi regarding the central bank’s plans to taper its monthly asset purchases. Markets are expecting the ECB to announce that it will begin reducing those purchases starting in January, down substantially from the current €60 billion/month. The key questions remain, however, as to the specific magnitude of that reduction as well as the planned duration of the longstanding asset purchase program. The ECB will likely be wary about sounding too hawkish or aggressive in its tapering plans, as any such talk or action would undesirably exacerbate euro strength.
The euro has generally been trading in a range against the US dollar for the past three weeks. Prior to this range trading, the euro saw a prolonged period of strength since the beginning of the year, particularly against the US dollar. The ECB decision on Thursday should help dictate if and in what direction the euro may break the current trading range. One likely scenario is that the central bank may advocate a more gradual tapering process over a longer period of time than expected, in part to avoid further euro strengthening. If this is the case, the euro could take a significant hit and EUR/USD could stumble, especially if Fed-driven dollar support continues.
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