Inflation in Canada during February is expected to have bumped back up. But, because it’s for technical reasons, the market seems to think it won’t affect the outlook for the BOC. The central bank’s focus is still on supporting the economy, which threatens to leave inflation below target.
At the last meeting, the BOC cut rates for the seventh time in a row. But, it was widely expected by the market, so there wasn’t a major reaction in the USDCAD. The usual dynamics of the exchange rate, however, have been significantly disrupted by the raging tariff war between Canada and the US. And this could significantly affect how the market reacts to the upcoming data.
What’s Driving the Currency Pair
Typically, the difference in interest rates is what moves currency pairs. But, with the Canadian economy facing a slowdown, the projections for the country’s GDP has taken over in terms of predicting where interest rates will go. But interest rates rely primarily on what the central bank is doing to combat inflation.
The thing is, there is a correlation between economic activity and inflation. The more money there is in circulation (that is, the more active the economy is), then inflation tends to go up. So, if the economy slows down, typically this means inflation will go down as well. This is why central banks have to support the economy in order to meet their inflation targets. By cutting interest rates, the increased borrowing is expected to speed up the economy. Which means that as the economy is expected to slow down, interest rates tend to drop in anticipation of further easing from the central bank.
What the BOC is Looking At
At its last meeting, Canada’s central bank put the emphasis on the economy, not so much the inflation rate. And not only that, but the imposition of tariffs on Canada by the Trump administration has taken center stage. The thing is, tariffs (and counter tariffs) are seen as inflationary, as they increase the cost of goods.
But it appears that the BOC is particularly worried that the tariffs will hurt consumers so much that the economy might slow down. Which means the lack of economic growth will likely be interpreted as more of a threat to inflation going down too much than tariffs raising consumer prices. With that emphasis by the BOC, traders are likely to look at inflation as confirming an already established intention to keep easing. In fact, analysts are projecting the BOC to cut rates down to 2.0% in short order.
What the Data Says
Friday’s CPI figures are expected to be higher on a technicality, which is the expiry of a short-term winter tax holiday which has depressed inflation over the last few months. Some analysts worry that it could be hiding a reflationary movement that could catch the BOC off guard. Even if the economy is underperforming, the BOC will have a hard time justifying rate cuts if inflation is going higher.
Canada’s February headline inflation rate is expected to tick up to 2.2% from 1.9% prior. Meanwhile, the central bank’s preferred measure, the Trimmed-Mean CPI, is expected to also advance to 2.8% from 2.7% prior. The BOC likes to keep the interest rate as close to the middle of the 1-3% target range as possible.