(Bloomberg) -- Canadian interest-rate markets moved to fully price in an additional quarter-point hike by the end of September and the local currency leaped, after the Bank of Canada unexpectedly tightened policy on Wednesday.
The Canadian two-year bond yield climbed more than 20 basis points to 4.59%, a level last seen in 2007. The local dollar jumped as much as 0.6% to C$1.3322 per greenback, putting it at levels last seen in May.
Policymakers led by Governor Tiff Macklem raised the overnight lending rate to 4.75% on Wednesday, the highest since 2001. The move was expected by only about one in five economists in a Bloomberg survey, and markets had put the odds at about a coin flip.
“Overall, excess demand in the economy looks to be more persistent than anticipated,” the bank said in its rate statement, which wasn’t accompanied by a new set of forecasts. Deputy Governor Paul Beaudry is set to speak Thursday, while Canadian jobs data comes out Friday.
The statement’s tone reflects concern that inflation may get “materially stuck” above 2%, wrote Shaun Osborne, chief FX strategist at Scotiabank. “A worry clearly referenced by Governor Macklem back in May as something that would drive a tighter policy rate,” he noted.
The moves in Canadian rate markets helped provide some support to shifts in the US, where traders boosted expectations for tightening in coming months and dialed back bets on easing by year end.
The Canadian move follows a similar hike by the Reserve Bank of Australia earlier in the week, while major central banks from the US, Europe and Japan are all scheduled to announce decisions next week.
Next week’s Federal Reserve meeting will at least partially determine whether the loonie can test a key level at C$1.3300.
For that to happen, “we will need confirmation that the Fed is taking a much more dovish stance than markets are discounting for,” said Jay Zhao-Murray, a currency analyst at Monex Canada in Toronto.
But with the RBA and now BOC having surprised markets this week with rate hikes, the onus is increasingly on the Fed to strike a hawkish tone, said Win Thin, global head of currency strategy at Brown Brothers Harriman. That in turn could boost the greenback against the Canadian dollar.
“To me, the RBA and BOC moves this week make it more likely the Fed hikes again, not less,” he said. “The statements from RBA and BOC are nearly identical in tone. The Fed could basically cut and paste and tell the same story here in the US.”
(Updates two-year Canadian yield, adds strategist comments and chart)
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