Key Talking Points

• Central banks to be in the spotlight in the coming months.
• BOC expected to act before ECB to curb price pressures.

Ever since economies started recovering from the COVID-19 pandemic shock, the talk of the town has been inflation and monetary policy. There is no doubt that central banks are going to be in the spotlight in the coming months, and how one bank performs compared to another is likely to be one of the main drivers of currency pairs in Q3.

That is why I’m focusing on EUR/CAD from a central bank differencing perspective, given how one seems to be leading the pack with regards to rate decisions, whilst the other is still trailing behind.

I have to say I was surprised to see EUR/CAD keeping to a tight range throughout May and June, given how the month of April was gearing up for a volatile second quarter. That said, the moves quickly reversed and the pair has been left trading pretty much where it ended the first quarter, which offers good opportunity going into Q3.

The Bank of Canada has been one of the first developed country banks to announce a tapering in its QE program as the bank adapts to improving domestic economic conditions. The interest rate projections remain unchanged up until mid-2022 but investors are likely expecting a policy shift before then, especially on the back of a continued rise in oil prices.

Meanwhile, the European Central Bank is likely to remain cautious about changing monetary policy until more solid economic data shows improving conditions. After the debacle of 2011, they’ll want to avoid the mistake of rising rates too early in order to allow the Eurozone economy to recover before withdrawing flexible financing conditions.

At least that is what market participants believe, with an implied 5% chance of a rate hike in December, compared to almost 22% for the Bank of Canada.

So, despite the tightening of monetary policy likely priced in the Canadian dollar, the likelihood of continued rising oil prices and stronger economic data than the Eurozone leads me to suggest a short EUR/CAD position going into Q3.

The weekly chart shows an intact descending trendline from the December 2020 high, limiting the pair’s upside in the medium-term. On that same chart, looking back to 2019 and 2017, there is a clear long-term support area around 1.4430, which would be my target for EUR/CAD in Q3.