Loonie gains as BoC hikes and Fed holds: interest-rate differential

Two central banks moved in different directions on Wednesday. Investing.com reports that the Canadian dollar, often called the loonie, held its gains after the Bank of Canada delivered a rate hike, while the US Federal Reserve kept its rates unchanged, according to its FOMC statement and the investingLive Americas wrap.

The official ECB fixing (a once-a-day reference rate, not a live quote) for USD/CAD on October 28 was 1.4047, up 0.17% from 1.4023 on October 27. The fixing is a single daily snapshot, so it may not capture market reactions to decisions released later in the day. Elsewhere, NZD/USD's fixing fell 1.57% to 0.5613, the biggest move in the pack, but our sources gave no reason for it. Our sister site has more on the loonie after the Bank of Canada hike. You can follow the pair on a USD/CAD chart.

What is an interest-rate differential?

An interest-rate differential is the gap between the interest rates of two countries. Each central bank sets a policy rate, the main rate that guides borrowing costs in its economy.

Money tends to flow toward places where it earns more. If Canada pays more on deposits and bonds than before, while US rates stay the same, holding Canadian dollars becomes a little more attractive. Traders watch the change in the gap more than its exact size. When one bank raises rates and the other holds, the gap shifts toward the bank that hiked.

Bond yields, the return investors get from government bonds, help show this. Investing.com reported that US Treasury yields were nudging toward one-week highs before the Fed decision, and investingLive noted the US yield curve steepened. These moves feed into the differential too.

A worked example

Our pack does not give the exact size of either policy rate, so we use the real fixings to show how a currency move shows up in money terms.

USD/CAD tells you how many Canadian dollars one US dollar buys.

• October 27 fixing: 1.4023
• October 28 fixing: 1.4047
• Change: 1.4047 − 1.4023 = 0.0024, or 24 pips
• Percentage: 0.0024 ÷ 1.4023 × 100 ≈ 0.17%

Now convert 10,000 US dollars:

1. At 1.4023: 10,000 × 1.4023 = 14,023 Canadian dollars
2. At 1.4047: 10,000 × 1.4047 = 14,047 Canadian dollars
3. Difference: 24 Canadian dollars more per 10,000 US dollars

Over five fixings the pair barely moved: from 1.4034 on October 22 to 1.4047, a 0.01% change. That shows a rate decision does not always produce a large move in the daily fixing. To read the differential, ask a simple question: did the gap move? Here, by the logic of the concept, a Canadian hike plus a US hold means the gap moved in Canada's favour by the size of the hike. Investing.com's report that the loonie held gains is consistent with that.

Why it matters for new traders

Interest rates are one of the strongest long-run drivers of currencies. When you see a headline about a central bank decision, compare it with what the other central bank in the pair is doing. A hike on its own tells you only half the story.

The differential is not the only force. Oil, trade news and risk mood also move the loonie. Markets also react to what traders expected, not only to the decision itself. And remember the timing issue: a daily fixing may be set before a decision is published, so check live charts for the full reaction.

Key terms

• Interest-rate differential: the gap between two countries' interest rates.
• Policy rate: the main interest rate a central bank sets.
• Bond yield: the return an investor earns from holding a bond.
• Pip: the smallest standard price step; for USD/CAD, 0.0001.
• Fixing: an official reference rate published once per business day.