Canadian Dollar gains against Euro despite softer domestic inflation data

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The Euro (EUR) weakens against the Canadian Dollar (CAD) on Tuesday as rising Oil prices linked to the US-Iran conflict continue to support the commodity-linked Loonie, even as the latest Canadian inflation data came in softer than expected.

EUR/CAD remains under pressure near two-week lows as higher Oil prices support the commodity-linked Canadian Dollar.
Canada’s softer-than-expected inflation data reinforces expectations that the BoC could keep rates unchanged in the near term.
Focus now shifts to Wednesday’s Eurozone inflation data amid uncertainty over the ECB’s tightening path.

Statistics Canada reported on Tuesday that Canada’s Consumer Price Index (CPI) rose 0.4% MoM in April, slowing from the 0.9% increase recorded in March and missing market expectations of 0.6%. On an annual basis, CPI accelerated to 2.8% from 2.4% previously, though the reading still came in below the 3.1% forecast.

Meanwhile, the Bank of Canada’s (BoC) core CPI eased to 2.1% YoY in April from 2.5% in the previous month, suggesting that higher energy prices are not yet spilling into broader inflation pressures.

The softer-than-expected inflation data, combined with weaker labor market figures released earlier this month, could allow the Bank of Canada (BoC) to keep its current policy stance unchanged as policymakers continue to look through the impact of higher energy prices.

However, markets continue to price in the possibility of a rate hike later this year if Oil-driven price pressures begin feeding more broadly into the economy.

Attention now turns to the Eurozone inflation data due on Wednesday, which could provide fresh clues on the European Central Bank’s (ECB) policy outlook. Economists expect the Core Harmonized Index of Consumer Prices (HICP) to remain unchanged at 2.2% YoY in April, while the monthly headline HICP is also forecast to hold steady at 1.0%.

Traders are currently pricing in at least two ECB rate hikes by the end of the year. However, the Eurozone’s heavy dependence on imported energy and the growing risk of slower economic growth are raising questions over whether the European Central Bank will be able to raise rates as much as markets expect.

ECB policymaker François Villeroy de Galhau said on Tuesday that the central bank “will be ready to act as needed,” while Joachim Nagel stated that the ECB will base its June decision on incoming data. Nagel also warned that the Eurozone is moving away from the baseline economic scenario and said the current energy supply shock appears more persistent.

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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