Canadian Dollar firms after hotter-than-expected inflation data
- The Canadian Dollar strengthens as inflation accelerates and the Greenback weakens.
- Markets expect the Bank of Canada to keep interest rates unchanged at 2.25% in September.
- Falling expectations for a September Fed rate hike keep the US Dollar on the defensive.
USD/CAD falls to its lowest level since June 3 on Monday as the US Dollar (USD) stays under pressure, while hotter-than-expected Canadian inflation data provide additional support to the Canadian Dollar (CAD). At the time of writing, the pair trades around 1.3852.
Canada’s Consumer Price Index (CPI) rose 3.0% YoY in July, above the 2.9% market forecast and up from 2.8% previously. On a monthly basis, CPI increased 0.5%, matching expectations and reversing the previous month's 0.4% decline.
Underlying inflation also picked up. The Bank of Canada’s (BoC) core CPI measure rose 2.3% YoY, up from 2.1%, while the monthly reading increased 0.2% following a 0.1% rise previously.
Statistics Canada said higher prices for gasoline and travel tours contributed to the acceleration in headline inflation. The agency added that “the conflict in the Middle East, including the blockade of the Strait of Hormuz,” placed upward pressure on fuel prices.
Despite the rise in headline inflation, the BoC’s preferred core measures held close to its 2% target, suggesting that the latest data are unlikely to change the central bank’s near-term policy outlook. The BoC will announce its next monetary policy decision on September 2 and is widely expected to keep its interest rate unchanged at 2.25%.
Meanwhile, the US Dollar stays on the back foot as traders dial back Federal Reserve (Fed) rate hike bets after recent US economic data pointed to weaker labour demand, softer consumer spending and easing inflation pressure.
According to the CME FedWatch tool, markets now assign around a 70% probability that the Fed will leave rates unchanged next month. The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, trades around 99.45 after touching 99.30, its lowest level since June 5.
Elsewhere, developments in the Middle East stay in focus as shipping through the Strait of Hormuz stays heavily restricted, keeping Oil prices elevated and providing a tailwind for the commodity-linked Loonie.
A senior Iranian official told Reuters that Tehran could raise tensions in the Strait of Hormuz and across the wider region if diplomacy fails. The official added that Tehran has decided to shift its policy from a defensive stance to a “fully offensive” one.
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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