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Will Canadian CPI Put a Cap on BOC, Finally?

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Headline inflation in Canada is expected to fall back to the top of the target range, which would normally imply that rate hikes were done and over with. But the current situation is unusual, and the markets might end up pricing in more chances of a hike after the data.

Part of the issue is the miss on inflation in the US reported last week. With the high level of interconnectivity between the countries, data south of the border can be an indication of what’s going on in Canada. Markets have moved to price in a lower CPI print for June, increasing the likelihood that it will overshoot. That could bring back talk about further rate hikes.

The path ahead

The BOC hiked rates twice in a row after an extended pause at the beginning of the year, as inflation started to tick up in the summer. This is a usual occurrence in Canada, where there is more economic activity in the middle of the year. Towards the end of autumn and winter, economic activity and the associated price pressure diminishes a bit. Additionally, there are base effects. Inflation leveled off in the back half of last year, which would translate into higher inflation readings even if the actual rate remains the same.

All of that leads the BOC to be more vigilant about price hikes. Additionally, the view from central bankers is that there will need to be at least one more rate hike in the US. In order to maintain price stability, it would be logical for the BOC to also be inclined to hike once more after September. The expectation is that September will be a “pause” month – despite Fed officials having introduced the “skip” notion for the May meeting.

How gauge the reaction

Therefore, the market is likely to try to parse tomorrow’s data in light of what it does for a potential rate hike after September. That’s relatively far away, so the reaction could be somewhat muted. The market believes that economic conditions will dictate that no more rate action will be necessary for the rest of the year.

So, if inflation is below expectations, it will likely simply confirm what the market already expects: The end of rate hikes from BOC. But if inflation were to overshoot, then it could bring back the potential for a third consecutive rate hike. And that could give the Loonie a bit of a boost, given the vast majority of traders expect the Fed to not hike in September.

What to look out for

Headline inflation is expected to fall back to 3.0%, down from 3.4% prior. Although the BOC’s ideal is a 2.0% inflation rate, that’s the midpoint of a 1-3% target. Technically, that would imply inflation is back to target. But the BOC cares more about core inflation, which is expected to remain stubbornly above target at 3.6% compared to 3.7% prior.

Just two decimals of beat over expectations would mean that core inflation is still rising, and that could radically shift the bets for another rate hike. Particularly if that is driven by a surprise in the monthly figure suggesting that inflation pressures remain high. The current forecast is for monthly core inflation to drop to 0.3% from 0.4% prior.

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