The Canadian dollar gave back part of its post-decision advance on Wednesday after a brief lift from the Bank of Canada announcement. USD/CAD was around 1.3925 at the time of writing, having earlier touched an intraday low of 1.3899. The BoC left its benchmark rate unchanged at 2.25% for a fifth straight meeting, matching expectations, while pointing to weak domestic activity, ongoing uncertainty over US trade policy and the war in the Middle East keeping oil prices elevated.
The central bank said there is limited evidence so far of broad-based pass-through from higher energy costs to other consumer prices, and indicated it is looking through the war’s near-term impact on headline inflation while remaining prepared to respond if needed. Governor Tiff Macklem said any potential move higher in rates would depend on conditions, and that a bout of broader inflation driven by energy could require consecutive rate hikes, with core inflation in focus. A firmer US dollar, supported by Middle East tensions and hawkish Federal Reserve expectations, kept USD/CAD biased higher.
Monetary Policy Divergence Supports USD/CAD Upside
The Bank of Canada’s decision to hold its rate at 2.25% signals caution, which contrasts sharply with expectations for a hawkish U.S. Federal Reserve. The current Fed Funds Rate sitting at 3.50% creates a significant interest rate differential that favors the US dollar. This divergence in monetary policy is a key driver for currency markets right now.
Fundamental Economic Divergence and Trading Outlook
We are seeing this weakness reflected in recent data, as Canada’s GDP grew by only 0.8% annualized in the first quarter of 2026. Conversely, the U.S. economy remains strong, with the latest Non-Farm Payrolls report showing a robust addition of 250,000 jobs. This fundamental economic divergence further supports a higher USD/CAD exchange rate.
While headline inflation in Canada is being pushed up by oil prices hovering around $95 a barrel, the BoC is focused on core inflation. The latest reading showed core CPI holding steady at 2.4%, giving policymakers room to wait before acting. They will likely not risk hurting an already fragile economy unless core prices accelerate.
Given this outlook, we believe the path of least resistance for USD/CAD is upward toward the 1.4000 level and beyond. We are looking at buying call options on USD/CAD with expiry dates in the next 30 to 60 days. This strategy allows us to profit from a potential rise while limiting our downside risk to the premium paid.
The current policy divergence is reminiscent of the 2014-2016 period, when the Fed began its hiking cycle while the BoC was on hold. During that time, the USD/CAD pair rallied significantly from below 1.10 to over 1.45. History suggests that such policy differences can lead to sustained, trending moves in the currency pair.
