-- The Canadian dollar (CAD or loonie) is close to unchanged versus the US dollar (USD) since the conflict in the Middle East began and is the fourth best performing currency alongside the US dollar (USD), with the Norwegian krone (NOK), Australian dollar (AUD) and sterling (GBO) outperforming, said MUFG.
The Bank of Canada meets on Wednesday and an unchanged monetary stance is widely expected at 9:45 a.m. ET policy statement, noted MUFG. Investors at the same time will also get the release of the Monetary Policy Report and they are likely to see a downward revision to gross domestic product growth for this year along with an upward revision to inflation.
Any downgrade to the BoC's GDP forecast for this year will likely reflect the impact of the start of the Iran war and should be "modest," writes the bank in a note to clients. Given the high level of uncertainty related to the conflict, these updated forecasts are unlikely to have the market impact they sometimes can have.
The same can be said in relation to the higher inflation forecasts, although MUFG sees greater risks of a more lasting impact on inflation. In a de-escalation scenario, it seems reasonable to the bank to assume that a retracement in energy prices will be to levels that are still higher than pre-conflict levels if you assume some amount of additional geopolitical risk premium is likely to remain.
That means a higher level of inflation than assumed before the conflict, which may become difficult to look through. The BoC indicated in March at the last meeting that it would focus more initially on downside growth risks than upside inflation risks. That in part reflects the fact that inflation was a little lower than expected at the start of the conflict.
However, at Wednesday's meeting the backdrop will be no end in sight to the closure of the Strait of Hormuz while risk assets have remained resilient. As a consequence, the bank expects the BoC to be certainly more hawkish than in March, with some signs of a shift in focus toward upside inflation risks.
However, the Federal Reserve also could be more hawkish on Wednesday and United States yields could move higher, resulting in limited moves in U.S.-Canada spreads, added MUFG. The bank's short-term bias favors the US dollar based on the increasing prospect of re-escalation of the conflict and a further rise in crude oil prices.
The latest IMM positioning data saw the largest week of CAD selling by Leveraged Funds since July 2024. While the Canadian dollar could underperform the US dollar in a re-escalation scenario, MUFG estimates moves to be more "modest" and for CAD to outperform other energy import-dependent G10 currencies.