Published: July 2nd, 2025
The Canadian dollar found itself pressurized by most other G10 majors this week as a steep drop in global oil prices offset CAD's recent gains against the US Dollar. There are now fresh concerns about the Loonie's outlook going into the Bank of Canada's July policy meeting.
CAD had strengthened notably last week, driving USD/CAD down to around the 1.3600 level after peaking at 1.3795 on June 23. Forex analysts at MUFG Bank said the decline in USD/CAD was caused by a broader pullback in US Dollar, after tensions cooled in the aftermath of the Israel-Iran conflict.
Despite those gains, the Loonie fell behind most major currencies on Monday and Tuesday, becoming the third-worst performer amongst the G10 since Monday, June 23. Only the US dollar and the Norwegian Krone fared worse.
‘Both the Loonie and Norwegian Krone have been hit by the steep and sudden drop in crude oil prices, with Brent crude sinking back under USD 70 a barrel,’ said MUFG in a note to investors this week.
Oil prices have begun to dip recently against the backdrop of a well-supplied market, MUFG analysts said, referencing the International Energy Agency's (IEA) Oil Market Outlook report for June 2025.
The IEA is forecasting global oil demand to rise by only 720,000 barrels per day for the remainder of 2025, well under last year's projected supply growth of 1.8 million barrels per day.
On the upside, crude's price weakness is helping offset possible inflation risks in Canada, potentially leaving Bank of Canada (BoC) policymakers more space to ease monetary policy.
Markets are currently pricing in around eight basis points in rate cuts going into the central bank's next meeting on July 30.
In March 2022 the Canadian dollar slipped against the greenback despite a significant rally in oil prices. Analysts believed that the divergence in crude and CAD pricing was likely to be temporary, though it wasn't the first time the traditional oil-loonie correlation had been broken.
CAD had fallen by around half a percentage point against the US dollar for the 2022 year-to-date. That was in defiance of a 60 per cent increase in global crude prices and a 34 percent gain for Canada's benchmark Western Canada Select crude oil in the same timeframe.
For investors who treat Canada's commodity dependent fiat as a petrocurrency, there's an ongoing expectation that its value will rise and fall in tandem with oil prices. The divergent price action therefore came as a shock. Analysts at Canada's CIBC bank, however, said the relationship between CAD and oil has been evolving for years. Many forex traders simply had not understood that things had changed.
In a market analysis, CIBC's currency research unit wrote that ‘despite what we've witnessed in terms of CAD's steadiness in the face of volatile crude prices, statistical evidence is building that supports the notion of a weaker link between oil and CAD, which tends to correspond with softening Canada-US interest differentials.’
CIBC's analysis showed that capital spending and investment in Canada's oil sector had fallen from almost four percent of GDP in late 2014 to just above one percent in 2021. That drop in capex happened regardless of oil price rises that occurred frequently through the period.
The take-away was that rising oil prices no longer came with a propensity to drive increased employment, income growth, or inflation. ‘That decoupling has meant that oil prices have less influence than they used to on Bank of Canada (BoC) monetary policy,’ CIBC wrote.
‘If we consider the period from late 2018, when capital spending in the Canadian oil sector had finished its retrenchment, the correlation disappears completely, even dipping into negative territory at times. Investors have stopped looking at oil prices as a driver of relative interest rates between Canada and America’.
‘Looking strictly at the last 12 months, the correlation has evaporated. That's arguably too small a window to make a sweeping statement about how oil will impact the loonie, or not. Oil is just one factor, and the last year has brought big changes in expectations for central bank policy. Whether it's been the fallout from pandemic or geopolitical tension, the drivers behind CAD prices have been much broader than crude oil prices.’
Despite any discomfort forex traders might experience when engaging in fundamental analysis, CIBC said the softening correlation between CAD and oil prices was a favourable development for Canadian upstream oil companies. It meant that their own foreign currency earnings were less likely to be at the whim of rising and falling loonie exchange rates.
‘They'll be in a better position to reap the benefits of climbing crude price per barrel without having profitability chipped away by appreciation in the Canadian dollar. On the flip side, if oil prices do start to retreat from recent highs, it shouldn't drag down demand for the loonie, which is what we would have expected to see in the past.’
A weaker oil-dollar dynamic could also potentially lead to a reduction in the extent to which domestic Canadian oil companies use currency hedging to reduce the risk of exchange rate volatility, which often involves buying more Canadian dollars.
Similarly, a lessened correlation could lend a supportive hand to the Loonie in periods when global oil prices are falling, and particularly if there has been a shift to large scale hedging positions.
The market support could arrive if spurred by already-lower hedge ratios and dipping oil prices, which might potentially lead to a rise in hedging-related demand for Canadian dollars.
CIBC says it continues to foresee a modest weakening in the loonie over the next two quarters, however that has less to do with any likely slippage in the oil price than with changes to Bank of Canada monetary policy.
