Should you buy the Canadian dollar ahead of the Bank of Canada’s rate decision?

One of the next week’s most important events for currency traders is the Bank of Canada (BOC)’s interest rate decision. The Canadian central bank has already raised the interest rates to 1.5%, becoming one of the most aggressive central banks in the developed world to do so during this tightening cycle.

But it is not enough.

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Despite the interest rate hikes, inflation remains well above the BOC’s target range of 1%-3%. In fact, all inflation measures (i.e., Total CPI, CPI-trim, CPI-median, and CPI-common), exceed the upper end of the range, pressuring the BOC to do more.

The market expects the central bank to raise the interest rate by 75bp next Wednesday, following the Federal Reserve’s lead. On top of inflation exceeding the bank’s target, the rate hike makes sense given the strong economic growth and a tight jobs market in Canada.

The Canadian dollar has emerged as a strong currency lately

The Canadian dollar (CAD) is one currency that has strengthened since inflation took most central banks by surprise. Because the Bank of Canada followed the Fed’s steps, the CAD appreciated in line with the US dollar.

As such, it gained against most of its peers, such as the euro or the Japanese yen. It did not gain against the US dollar, but it makes sense given the strength of the dollar and the rising oil prices.

Speaking of oil prices, they have a particular influence on the Canadian and the US dollar. Because Canada is a major oil exporter, the rise in oil prices from negative territory to above $100/barrel was a positive for the Canadian dollar.

But oil is denominated in US dollars. Therefore, higher oil prices have contributed to the strength of the greenback while literally, all other currencies weakened.

A strong currency is an asset in times of rising prices for goods and services. Coupled with a central bank’s willingness to raise rates, further CAD strength is expected, especially against currencies other than the US dollar.

For instance, the Canadian dollar may continue its rally against the euro and the Japanese yen. Both the European Central Bank and the Bank of Japan are way behind in the tightening race, and next Wednesday’s rate hike from the Bank of Canada would only widen the interest rate differential.