Investing.com – The Canadian dollar retreated to three month lows against its U.S. counterpart on Tuesday, as cooler than expected domestic CPI data boosted expectations for a June rate cut from the Bank of Canada. The data also heightened expectations for the level of easing to be delivered by the BoC this year.
The headline Canadian consumer price index reading rose 2.8% last month on an annualized basis: its slowest pace since June, and core inflation measures eased to more-than two-year lows. On a monthly basis, the CPI climbed 0.3%, versus expectations for a 0.6% increase.
The Bank of Canada’s two preferred core inflation measures also slowed, averaging a 3.15% yearly pace from 3.35% a month earlier.
Following the release of the data, money markets now see a 75% chance of the BoC easing in June, up from roughly 50/50 prior to the release.
Money markets are also now pricing in over 75 basis points of rate cuts from the BoC in 2024, compared to expectations for 60 bps in cuts prior to the CPI release.
Simon Harvey, head of FX analysis for Monex Europe and Monex Canada notest that, “The Canadian economy is much weaker than the headline data suggests, and we’re now starting to see that weakness manifest within nearly all macro indicators, even the BoC’s preferred core measures of inflation that were a major sticking point for the bank back in 2023,”
In terms of the impact on the loonie, Harvey sees two possible scenarios: “For the Canadian dollar, whether the Bank cuts in April or delays until June effectively generates two scenarios; one in which we believe USDCAD could trend up to 1.38 in the short-term and another where the pair could breach 1.40 in the medium-term.”
Harvey notes that the more pragmatic approach of cutting in April as inflation cools and the Canadian economy slows, should provide a headwind to the loonie “as FX markets will respond unfavourably to the earlier sequencing of rate cuts in Canada”. However, the pressure on the loonie should be “temporary and offset over the medium term by the positive growth impact and likely higher terminal rate.”
On the other hand, a BoC rate cut delay to June “Will help shelter the loonie against a more hawkish Federal Reserve in the short-term”. However, a delay till June in the medium term would result in further pain inflicted on the Canadian economy, and ultimately raise “the risk the BoC will need to cut rates faster and to a lower terminal level than the Fed over the medium-term.”
Up next for the USDCAD pair, all eyes will be on a rate decision from the U.S. Federal Reserve, due tomorrow at 2:00 p.m ET.