Published: January 10th, 2024
News that Canadian inflation unexpectedly rose in November gave the Loonie a lift in early trading this week, but analysts at Toronto bank CIBC say the long-term trend still points to a continuing decline that will free the Bank of Canada to cut interest rates before mid-year.
CAD rose against the US Dollar, Euro, and Pound following publication of the latest inflation print by Statistics Canada. It said November CPI inflation had risen by 3.09 per cent year-on-year, unchanged from October but higher than the consensus reading of 2.9 per cent.
A 0.1 per cent month-on-month increase helped fuel the rise, which was also from the previous month and similarly exceeded the consensus forecast of -0.2 per cent.
The Canadian Dollar was under pressure at last Friday's close after comments from Bank of Canada Governor Tiff Macklem, who told a news conference that interest rate cuts are on the agenda for 2024.
In an analyst note released this week, CIBC said the Loonie’s strength could be limited, as the StatsCan figures give little room for central bank policy makers to wiggle out of cut rates in the coming months.
Canada’s inflation drivers are becoming less diffuse and easier to track, CIBC says, and softer trends prevailed in the Bank of Canada's preferred core measures of CPI-trim and CPI-median, 3.4 per cent and 3.3 per cent, respectively. On a 3-month annualised basis, those measures were even softer at 2.3 per cent and 2.5 per cent.
‘While three-month annualised readings can be volatile, if these trends continue for another few months, Bank of Canada policymakers will grow more confident that headline inflation is returning to target. Despite the upside surprise in headline inflation, that paves the way for interest rate cuts from the second quarter of this year.’
A gloomy set of forecasts at mid-year 2023 suggested expectations were growing for a steady decline in the Canadian Dollar's value against the Euro, Pound, and US Dollar.
Despite a bout of outperformance by CAD, investment bank MUFG said the Loonie would experience headwinds as economic worries rose to the forefront.
Analysts at the bank’s Global Markets EMEA unit wrote in a mid-year update that CAD’s recent strength has been mainly driven by the Bank of Canada's (BoC) recent decision to re-start its monetary tightening cycle.
A later economic print, however, suggested there may be weakness in Canada’s labour market alongside a distinct decline in inflation. Both raised trader concerns about how sustainable the Canadian dollar's strength might be.
MUFG pointed to shifting trader expectations about the BoC's monetary policy and the significant role those expectations played in driving the Loonie's appreciation. The two-year US-Canada spread, which tracks the yield differential between the two nations, saw a notable move of nearly 100 basis points from its peak in April to its low in June 2022.
While the USD/CAD pair wasn't sensitive to the shift initially, CAD started to appreciate notably in late May, rising from levels above 1.3602.
The BoC's move to tighten monetary policy was triggered by data that suggested domestic economic resilience.
Other indicators, however, exposed ‘weaknesses in the labour market, with a drop in full-time employment of 32.6 thousand seen in May,’ MUFG analysts wrote. They added that the fight to curb inflation has been successful, lowering the headline Consumer Price Index (CPI) to the BoC's target Median CPI.
MUFG also said that the Loonie’s performance would o be influenced by the ongoing resilience of equity markets.
In May 2023, data showing resilient Canadian consumer spending had analysts predicting a period of CAD gains.
CAD climbed alongside the Greenback after publication of Statistics Canada data that captured strong retail sales in March, helping underpin growth expectations for North America’s second-largest economy.
Though sales figures were down -1.39 per cent in overall terms for March when big ticket purchases like cars were included in the calculation, sales volume fell by a lesser -0.98 per cent, which suggests widespread discounting by main street shops.
That led to the cash value spending growth of 0.3 per cent in March when sales of cars, petrol, and repair parts were excluded. Overall sales look to have rebounded by 0.2 per cent the following month.
'The drop in March retail sales, and the incremental rebound in April points to Canadian consumers starting to feel the impact of higher interest rates,’ said economists at RBC in Toronto in an analyst commentary following publication of the data.
While RBC number crunchers may have been underwhelmed by the data, CAD bulls took consolation from the fact that the Canadian economy benefitted from widespread discounting that helped keep sales volumes aloft for the first quarter as a whole.
The distinction is significant. It’s sales volumes (as opposed to values) that are measured in calculations of a country’s economic output. It means consumer spending probably helped sustain Canada’s economy through the opening quarter of the year and stopped it from contracting.
The Loonie got an earlier boost in February 2023 by figures showing Canada's labour market was undergoing its strongest expansion in 12 months.
GBP/CAD stepped back from a brief multi-month rally above September's all-time low, however analysts think it could still settle above recent moving averages if official data from the UK side point to a healthy British labour market.
'Recent Canadian labour market numbers won’t change the perception of economic overheating,’ said HSBC’s FX Strategy Unit in a Monday market analysis. 'While the number of new jobs created was surprisingly high, wage growth also stayed above four per cent.’
'The year-on-year wage rise of 4.4 per cent in January was the lowest posted since July, however the Bank of Canada believes that wage growth needs to fall below four per cent to keep inflation at its target two per cent ceiling.’