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Inflation in Canada is expected to cool further in July, leading to further interest rate cuts by the BoC

  • The Canadian consumer price index is expected to continue to lose momentum in July.
  • The BoC could extend its easing cycle in the second half of the year.
  • The Canadian dollar appears to be stable against its US counterpart so far in August.

Canada will release its latest inflation figures on Tuesday. Statistics Canada will release the Consumer Price Index (CPI) data for July. Forecasts suggest a continuation of disinflationary trends in the CPI, while a further rise in the core reading, as in June, could make the release a little more volatile.

In addition to the CPI data, the Bank of Canada (BoC) will also release its core consumer price index, which excludes volatile components such as food and energy. In June, the BoC's core CPI recorded a 0.1% decline from May's reading and a 1.9% increase over the past 12 months, while the headline CPI rose 2.7% over the past year and contracted 0.1% from the previous month.

These numbers will be closely watched as they could impact the Canadian dollar (CAD) in the short term and shape expectations regarding the Bank of Canada's monetary policy, especially after the central bank cut its key interest rate by another 25 basis points (bps) to 4.50% in July.

In the forex world, the Canadian dollar gained strong ground after hitting a yearly low of 1.3950 against the greenback on August 5. So far, the USD/CAD downside remains well-shielded by the key 200-day SMA at 1.3600.

What can we expect from Canada's inflation rate?

Analysts expect price pressures in Canada to continue to trend lower in July, although they will likely still be above the central bank's target. Consumer prices are expected to follow the recent trend in the US, where lower-than-expected CPI data fuelled speculation of a 50 basis point rate cut by the Federal Reserve (Fed) in September. Although those expectations subsequently fizzled out and US macro data delivered strong results, the Fed is widely expected to cut rates by 25 basis points next month.

If the upcoming data meets these expectations, investors could speculate that the Bank of Canada (BoC) could further ease its monetary policy with another quarter-percentage point rate cut, possibly lowering the benchmark interest rate to 4.25% at its September 4 meeting.

According to the minutes of their July meeting, BoC governors expressed concern about weaker consumer spending in 2025 and 2026 compared to expectations. Lower borrowing costs could boost spending, but households would still face debt servicing, hampering any recovery. Economic growth is lagging behind population growth, leading to excess supply and slack in the labor market. This could weaken the labor market and dampen consumption, which in turn would impact growth and inflation.

Back to inflation: Following last month's rate cut, BoC Governor Tiff Macklem argued that the economy is experiencing excess supply and the slack in the labor market is carrying downward pressure on inflation. He noted that their assessment indicates that there is already sufficient excess supply in the economy and stressed that the focus should not be on increasing excess supply but on promoting growth and job creation to absorb this excess and achieve a sustainable return to the 2% inflation target.”

Analysts at TD Securities commented: “Markets will look to the consumer price index for July for a final update on underlying price pressures ahead of the BoC decision in September. TD forecasts a 0.2 percentage point decline to 2.5 percent year-on-year, although stronger core inflation dynamics should give the report a mixed tone.”

When will the Canadian CPI data be released and what impact could it have on USD/CAD?

On Tuesday at 12:30 GMT, Canada will release the Consumer Price Index (CPI) for July. The Canadian dollar's reaction will largely depend on any changes in expectations regarding the Bank of Canada's (BoC) monetary policy. However, unless the data contains major surprises, the BoC is expected to maintain its current easing stance, somewhat in line with the stance of other central banks such as the Fed.

USD/CAD started the month on a strong note, rising to a yearly high around 1.3950. However, the Canadian currency regained momentum and was trading almost three cents lower at the time of writing, in parallel with a sharp corrective decline in the US dollar (USD).

Pablo Piovano, senior analyst at FXStreet, says USD/CAD appears well supported by the critical 200-day SMA around 1.3600. A break of this level could trigger further weakness to the next notable support at the March low of 1.3419 (March 8), ahead of the weekly low of 1.3358 from January 31.

On the upside, Pablo adds, immediate resistance is found at the 2024 high at 1.3946 (August 5), ahead of the key milestone of 1.4000 (June 11).

Pablo also noted that a significant increase in CAD volatility would likely depend on unexpected inflation data. If the CPI comes in below expectations, it could strengthen the argument for another BoC rate cut at the upcoming meeting, leading to a rise in USD/CAD. On the other hand, if inflation exceeds expectations, the Canadian dollar could see only modest support.

Economic indicator

BoC Core Consumer Price Index (year by year)

The BoC Consumer Price Index Core, released monthly by the Bank of Canada (BoC), represents price changes for Canadian consumers by comparing the costs of a fixed basket of goods and services. It is considered a measure of underlying inflation because it excludes eight of the most volatile components: fruits, vegetables, gasoline, heating oil, natural gas, mortgage rates, long-distance transportation and tobacco products. The YoY value compares prices in the reference month with those of the same month last year. Generally, a high value is considered bullish for the Canadian dollar (CAD), while a low value is considered bearish.

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Last publication: Tue, 16 July 2024, 12:30

Frequency: Monthly

Actually: 1.9%

Consensus: –

Previous: 1.8%

Source: Statistics Canada

Frequently asked questions about inflation

Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a monthly (MoM) and annual (YoY) basis. Core inflation excludes more volatile items such as food and fuel, which can fluctuate due to geopolitical and seasonal factors. Core inflation is the number that economists focus on and is the target level of central banks, whose job it is to keep inflation at a manageable level, usually around 2%.

The Consumer Price Index (CPI) measures the change in the price of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a monthly (MoM) and annual (YoY) basis. The core CPI is the figure targeted by central banks as it excludes the volatile food and fuel imports. When the core CPI rises above 2%, it usually leads to higher interest rates and vice versa when it falls below 2%. Since higher interest rates have a positive effect on a currency, higher inflation usually leads to a stronger currency. The opposite is true when inflation falls.

Although it may seem counterintuitive, high inflation in a country drives up the value of its currency, and vice versa when inflation is low. This is because the central bank usually raises interest rates to combat higher inflation, which attracts more global capital inflows from investors looking for a lucrative place to park their money.

Gold used to be the asset that investors relied on during times of high inflation because it preserved its value. And while investors often still buy gold as a safe haven during times of extreme market turmoil, in most cases this is not the case. That's because when inflation is high, central banks raise interest rates to combat it. Higher interest rates are negative for gold because they increase the opportunity cost of holding gold compared to an interest-bearing asset or putting the money in a bank deposit account. On the other hand, lower inflation tends to be positive for gold because it lowers interest rates and makes the precious metal a more profitable investment alternative.

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