USD/CAD drifts lower as Canada CPI shows mixed inflation signals ahead of BoC decision

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USD/CAD trades on the back foot on Monday as the Canadian Dollar (CAD) draws support from a softer US Dollar (USD), while traders show a muted reaction to the latest Canadian inflation data as attention remains firmly focused on heightened geopolitical tensions surrounding the ongoing US-Iran war.

USD/CAD weakens as the Canadian Dollar gains support from a softer US Dollar.
Markets show limited reaction to Canada’s latest inflation data ahead of the BoC rate decision.
Geopolitical tensions linked to the US-Iran war remain a key driver of market sentiment.

At the time of writing, the pair is trading around 1.3659, pausing after a three-day winning streak that pushed the pair to two-week highs. Meanwhile, the US Dollar Index (DXY), which measures the Greenback against a basket of six major currencies, trades near 100, easing from the 10-month high of 100.54 reached on Friday.

Headline Consumer Price Index (CPI) rose 0.5% MoM in February, slightly below market expectations of 0.6% but rebounding from 0.0% in January, while the annual rate slowed to 1.8% YoY from 2.3%, coming in just under the 1.9% forecast.

The Bank of Canada’s (BoC) core CPI increased 0.4% MoM, accelerating from 0.2% in January, although the annual core measure eased to 2.3% YoY from 2.6%.

The data point to easing price pressure, reinforcing expectations that the Bank of Canada (BoC) will maintain a steady policy stance as policymakers remain focused on keeping inflation close to the 2% target.

However, last week’s disappointing employment data raises the possibility that the central bank could reassess its monetary policy stance if the labor market continues to deteriorate.

Attention now turns to the BoC’s interest rate decision due on Wednesday, where policymakers are widely expected to keep the benchmark rate unchanged at 2.25%.

At the same time, the BoC could face a policy dilemma amid elevated Oil prices driven by supply disruptions through the Strait of Hormuz. While higher crude prices could add to inflation risks, Canada is also a major Oil exporter, meaning stronger energy prices may support economic growth.

As a result, policymakers may prefer a wait-and-see approach as they assess the economic impact. A Reuters poll published on March 13 showed that 25 of 33 economists expect the central bank to keep rates unchanged at least through 2026.

Markets are also reassessing the Federal Reserve’s (Fed) policy outlook, with traders scaling back expectations for rate cuts this year. The Fed is widely expected to keep interest rates unchanged in the 3.25%-3.50% range at Wednesday’s policy meeting. Investors will closely watch Fed Chair Jerome Powell’s forward guidance, along with the updated Summary of Economic Projections (SEP) and the dot plot.

Bank of Canada FAQs

What is the Bank of Canada and how does it influence the Canadian Dollar?

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.

What is Quantitative Easing (QE) and how does it affect the Canadian Dollar?

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.

What is Quantitative tightening (QT) and how does it affect the Canadian Dollar?

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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