Canadian Dollar weakens below 1.3650 on softer CPI inflation, lower crude oil prices

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USD/CAD gathers strength to near 1.3645 in Wednesday’s Asian session.
Canada's annual inflation rate declined to 2.3% in January, softer than expected.
Traders brace for the FOMC Minutes later on Wednesday.

The USD/CAD pair gains ground to around 1.3645 during the Asian trading hours on Wednesday. The Canadian Dollar (CAD) weakens against the US Dollar (USD) on a softer inflation report and lower crude oil prices. All eyes will be on the Federal Open Market Committee (FOMC) Minutes, which are due later on Wednesday.

Data released by Statistics Canada on Tuesday showed that Canada’s Consumer Price Index (CPI) inflation eased to 2.3% YoY in January from 2.4% in December. This figure came in below the market consensus of 2.4%. This report reinforced the case that the Bank of Canada will cut the key interest rate again, weighing on the Loonie against the USD.

Meanwhile, crude oil prices fall amid easing tensions between the US and Iran. Iranian Foreign Minister Abbas Araqchi stated on Tuesday that both countries reached an understanding on the main “guiding principles” in talks aimed at resolving their longstanding nuclear dispute, but that does not mean a deal is imminent. This headline undermines the commodity-linked CAD. It is worth noting that Canada is a major oil-exporting country, and low crude oil prices generally have a negative impact on the Loonie.

The attention will shift to the FOMC Minutes on Wednesday. The report could offer some hints about the US Federal Reserve's (Fed) future interest rate outlook. Any dovish stance of the Fed could drag the US Dollar (USD) lower in the near term.

Canadian Dollar FAQs

What key factors drive the Canadian Dollar?

The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada’s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.

How do the decisions of the Bank of Canada impact the Canadian Dollar?

The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.

How does the price of Oil impact the Canadian Dollar?

The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canada’s biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.

How does inflation data impact the value of the Canadian Dollar?

While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian Dollar.

How does economic data influence the value of the Canadian Dollar?

Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.