U.S. dollar declines after Bank of Canada delivers ‘surprise’ rate hike

The U.S. dollar fell in Asian trading after the Bank of Canada or BoC delivered a "surprise" rate hike, bringing the country's key overnight rate to 4.75 percent, the highest in over two decades.

The DXY, an index that keeps tabs on the dollar's performance against major peers, declined by 0.08 percent to 103.96 in the Asian forex market. The Canadian dollar rose to C$1.3363 per U.S. dollar after previously hitting a one-month high of C$1.3321.

According to OANDA market analyst Edward Moya, the BoC's decision significantly influenced financial markets because the Canadian central bank is considered "proactive with monetary policy." Policymakers at the central bank have said they will monitor key economic data to see the country's progress in slowing inflation, indicating that further monetary tightening is possible.

Sterling strengthened by 0.13 percent to $1.2455, while the euro traded 0.14 percent higher to $1.0712. Klaas Knot, a governing council member of the European Central Bank (ECB), said Wednesday that he expected his agency to deliver rate increases in June and July. The ECB last hiked the eurozone's key interest rate by 25 basis points to 3.75 percent.

Against the Japanese yen, the dollar declined by 0.28 percent to 139.76 after Japan revised its Q1 gross domestic product data, showing that the country's economy grew more than earlier estimates from January to March. The yen breached the critical level of 140 per dollar last month, prompting financial authorities to conduct an emergency meeting to discuss the volatility of the Japanese currency in forex trading.

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The Australian dollar gained 0.17 percent to trade at $0.6664 against the greenback after falling by almost 0.3 percent the day before. Similar to the BoC, the Reserve Bank of Australia hiked its benchmark rate by 25 basis points to 4.10 percent on Tuesday. The central bank's officials also warned of more hikes in the future.

Meanwhile, New Zealand's dollar traded 0.24 percent higher to $0.6051 against the U.S. dollar. It lost 0.7 percent in the previous trading session.

The onshore and offshore yuan also fell to their lowest levels in six months versus the greenback. Official data published on Wednesday revealed that China's exports and imports declined last month. National Australia Bank head of FX strategy Ryan Attrill said the trade data provided "another symptom of a faltering recovery" in China.

Market anticipates Fed's policy meeting

Market experts say the market's anticipation about the U.S. Federal Reserve's monetary policy move will affect financial markets in the coming days. Strategists at multinational financial firm ANZ wrote in a note that the Fed was "leaning toward skipping a rate hike at this meeting and potentially tightening more later."

According to ANZ, the Federal Open Market will likely revise up the gross domestic product and inflation forecasts for the year, increasing the chance of a higher terminal federal fund rate. Fed fund futures now forecast a 69 percent probability that the Fed will maintain its benchmark rate of 5.00 to 5.25 percent.

Economists have warned that the Fed's tight monetary policy can push the U.S. economy into a recession since it began raising rates in March 2022. Analysts point out several risks in the Fed's monetary policy pathway, including the recent banking turmoil and debt ceiling crisis.

The regional banking stress in the U.S., which started with the sudden shutdown of Silicon Valley Bank in March, caused tighter credit requirements imposed by banks to their clients. Adding to the issue, the Treasury Department will issue more than $1 trillion worth of government bills over the following weeks to replenish its cash reserves.

According to analysts, the Treasury's action will draw significant liquidity from the market, further reducing credit availability for American companies and households. Analysts expect to see more decline in economic activity and consumer confidence.