Loonie strengthens for third day as core inflation rises, US Dollar stumbles
- The Canadian Dollar extends gains against the US Dollar on Wednesday, with USD/CAD falling below 1.3900.
- BoC rate cut expectations fade as underlying inflation remains sticky.
- The US Dollar remains under pressure, DXY slips to a fresh weekly low.
The Canadian Dollar (CAD) strengthens further against the US Dollar (USD) on Wednesday, marking a three-day rally, with USD/CAD slipping below 1.3900 as markets digest stronger-than-expected Canadian inflation figures and a broadly subdued Greenback.
The market reacted to the data released on Tuesday with renewed uncertainty as Canada’s inflation report showed an unexpected rise in core prices despite a steep drop in the headline figure. The headline Consumer Price Index (CPI) rose to 1.7% YoY in April, down from 2.9% in March. On a monthly basis, the CPI fell 0.1% in April from 0.3% in March, well below market expectations. In contrast, the Bank of Canada’s (BoC) preferred measure, BoC core CPI, accelerated to 2.5% YoY, from 2.2%, and monthly CPI rose to 0.5% MoM from 0.1% in March.
The fall in headline inflation was partly driven by weaker energy prices, which fell 12.7% YoY in April as the recent removal of the federal carbon tax intensified the impact of falling oil prices driven by OPEC's decision to hike output.
The latest inflation data paints a complex picture for the BoC ahead of its June rate decision. The BoC held its benchmark interest rate steady at 2.75% during its April policy meeting. Some economists now lean toward another pause in cuts.
While the headline inflation figure eased, the rise in core measures indicates underlying price pressure picked up in April.
“It is going to make it a much more challenging backdrop for the Bank of Canada to continue cutting rates, at least in the near term,” said Benjamin Reitzes, Managing Director of Canadian Rates and Macro Strategist at BMO Capital Markets.
On top of that, the impact of US trade tariffs is adding to the uncertainty, potentially keeping inflation higher for longer and making it harder for the central bank to move ahead with its easing plans.
Meanwhile, the US Dollar Index (DXY), which measures the USD against a basket of six major currencies, briefly slipped below the 100.00 mark to a fresh weekly low, down over 1.2% this week. The Greenback remains under pressure amid a broader weakness in the US economy after Moody’s cut the US sovereign credit rating to Aa1 on May 16 and a cautious economic outlook from the Federal Reserve (Fed).
Looking ahead, traders will keep a close eye on the US Purchasing Managers Index (PMI) data due on Thursday and Canada’s upcoming Retail Sales data on Friday. At the same time, shifts in US economic policy and ongoing global trade developments will continue to play a key role in shaping the direction of the USD/CAD pair.
Bank of Canada FAQs
The Bank of Canada (BoC), based in Ottawa, is the institution that sets interest rates and manages monetary policy for Canada. It does so at eight scheduled meetings a year and ad hoc emergency meetings that are held as required. The BoC primary mandate is to maintain price stability, which means keeping inflation at between 1-3%. Its main tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Canadian Dollar (CAD) and vice versa. Other tools used include quantitative easing and tightening.
In extreme situations, the Bank of Canada can enact a policy tool called Quantitative Easing. QE is the process by which the BoC prints Canadian Dollars for the purpose of buying assets – usually government or corporate bonds – from financial institutions. QE usually results in a weaker CAD. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The Bank of Canada used the measure during the Great Financial Crisis of 2009-11 when credit froze after banks lost faith in each other’s ability to repay debts.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the Bank of Canada purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the BoC stops buying more assets, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Canadian Dollar.
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