Will a slight decline in Canada’s CPI lead to the Bank of Canada cutting interest rates?
- Canada’s Consumer Price Index is expected to rise 1.8% year over year in December.
- The Bank of Canada has cut interest rates by 175 basis points in 2024.
- The Canadian dollar is on the move to multi-year lows against its US counterpart.
Statistics Canada is scheduled to release its latest inflation report for December, based on the Consumer Price Index (CPI), on Tuesday. Early forecasts suggest that headline inflation may have risen by 1.8% compared to the same month a year earlier.
In addition to the headline numbers, the Bank of Canada (BoC) will publish core CPI data, which excludes more unpredictable items such as food and energy. For context, the core CPI for November showed a 0.1% contraction compared to the previous month but showed a 1.6% increase from a year earlier. Meanwhile, November’s headline inflation rate rose by just 1.9% year-on-year, virtually flat on a monthly basis.
These inflation numbers are under the microscope, especially because of their potential impact on the Canadian Dollar (CAD). The Bank of Canada’s approach to interest rates plays a crucial role here. The central bank has already cut interest rates by 175 basis points since it began easing in June 2024, reaching 3.25% on December 11.
On the currency front, the Canadian dollar has faced major challenges, as it has steadily lost its value. This pushed the USD/CAD exchange rate to its highest levels since May 2020, breaching the 1.4400 level. Markets will pay close attention to Tuesday’s data to gauge what might happen next for the Canadian economy and its currency.
What can we expect from Canada’s inflation rate?
The Bank of Canada’s decision to cut interest rates by 50 basis points on December 11 to 3.25% was a close call, according to meeting minutes published on December 23. Some council members favored a smaller cut of 25 basis points, which led to significant debate. Governor Tiff Macklem noted that future cuts are likely to be more gradual, marking a shift from previous messaging about the need for continued easing. Proponents of a deeper cut cited concerns about weak growth and downside inflation risks, although recent data did not support such an aggressive move. The decision highlights the Central Bank’s careful handling of economic uncertainty.
Previewing the data release, analysts at TD Securities noted: “We look for CPI to rise to 2.0% y/y with prices falling 0.2% m/m. Monsoon headwinds will impact commodities significantly on a m/m basis, while providing… Food prices and weak Canadian dollar a source of strength Core inflation should slow by 0.2 basis points to 2.45% y/y on average, as CPI/average trim exceeds Bank of Canada expectations. For the fourth quarter, but we expect the Bank of Canada to look at this in January.
When will Canadian CPI data be released, and how could it affect the USD/CAD?
Canada’s December inflation report is due out on Tuesday at 1:30 GMT, but the Canadian dollar’s reaction will likely depend on whether the data delivers any big surprises. If the numbers are in line with expectations, they are unlikely to impact the Bank of Canada’s current interest rate forecasts.
Meanwhile, the USD/CAD pair has been floating in a consolidation range since mid-December, reaching multi-year highs behind the 1.4500 barrier. This rally was primarily driven by a strong rebound in the US dollar, largely attributable to the so-called “Trump trade,” which continues to put significant pressure on risk-sensitive currencies such as the Canadian dollar.
Pablo Piovano, Senior Analyst at FXStreet, notes that given the current scenario of continued gains in the US dollar and increased volatility in crude oil prices, further weakness in the Canadian dollar should remain on the way for the time being.
Piovano adds: “Upside attempts should lead USD/CAD to another possible visit to the 2024 peak at 1.4485 (Jan 20), ahead of the 2020 high of 1.4667 (March 19). March)”.
On the downside, there is an initial support area at the 2025 low at 1.4278 (Jan 6), ahead of the 55-day SMA at 1.4177 and the 1.4000 psychological threshold. Hence the November low at 1.3823 (Nov 6), followed closely by the 200-day SMA at 1.3816. If USD/CAD falls below this level, it could lead to additional selling pressure, Piovano notes, initially targeting the September low of 1.3418 (September 25).
Economic indicator
Consumer Price Index (monthly)
The Consumer Price Index (CPI), which is released by Statistics Canada on a monthly basis, represents changes in prices for Canadian consumers by comparing the cost of a fixed basket of goods and services. The monthly figure compares commodity prices in the reference month with the previous month. In general, a high reading is considered bullish for the Canadian Dollar (CAD), while a low reading is considered bearish.
Read more.
Next release: Tuesday 21 January 2025 at 1:30
repetition: monthly
consensus: -0.7%
former: 0%
source: Statistics Canada
Frequently asked questions about inflation
Inflation measures the rise in the prices of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a monthly (MoM) and yearly (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 level targeted by central banks, which are tasked with keeping inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices 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 yearly (YoY) basis. The core CPI is the number targeted by central banks because it excludes volatile food and fuel inputs. When the core CPI rises above 2%, it typically causes interest rates to rise and vice versa when it falls below 2%. Since higher interest rates are positive for 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 causes the value of its currency to rise and vice versa for lower inflation. This is because the central bank will typically raise interest rates to combat rising inflation, which attracts more global capital flows from investors looking for a profitable place to park their money.
Previously, gold was the asset investors turned to during times of high inflation because it maintained its value, and while investors often continue to buy gold for its safety properties in times of extreme market turmoil, this is not the case most of the time. . This is because when inflation is high, central banks will raise interest rates to combat it. High interest rates are negative for gold because they increase the opportunity cost of holding gold versus interest-bearing assets or putting money in a cash deposit account. On the flip side, lower inflation tends to be positive for gold because it lowers interest rates, making the shiny metal a more viable investment alternative.
