Canadian Dollar Advances on Rivals after Inflation Surges in February; BoC in Focus

- CAD surges after strong rise in February inflation.

- Retail sales disappoint on automobile weakness.

- Strategist opinions mixed on the USD/CAD. 

© Viv Idrange, Adobe Stock

The Canadian Dollar rose sharply during noon trading Friday as traders reacted to a much stronger than expected rise in Canada's inflation rates during February, which could now have implications for Bank of Canada monetary policy. 

Headline inflation rose by 0.6% during the January February month, up from 0.7% in January and far ahead of the 0.4% rise expected by the market. This has pushed Canada's annual rate of inflation to 2.2%, which is above the Bank of Canada's 2% target. 

"Inflation is BAAAACK, but its not yet a scary monster, being essentially in line with what the Bank of Canada actually wanted to see. As we expected, the numbers were firmer than the consensus was looking for," says Avery Shenfeld, chief economist at CIBC Capital Markets.

Core inflation, which removes volatile energy goods from the price basket and so is seen as more representative of domestically generated inflation pressures, rose 0.7% on the month. This leaves the annual rate of core inflation sitting at 1.5%. The trimmed mean, common CPI and median CPI metrics preferred by the Bank of Canada also all nudged higher, taking them up to or above the 2% target. 

"The three core measures tracked by the BoC now average right on the Bank's 2% target. The minimum wage hike in Ontario doesn't seem to be a big factor, since that province's monthly and annual CPI figures are only in line with the average," Shenfeld adds.

Separately, Canadian retail sales grew by 0.3% during January, which is up from the -0.8% contraction seen in December but below the 1.1% growth the market was looking for. Nonetheless core retail sales, which remove large ticket items like automobiles from the data, rose by 0.9% during the month - which was in line with market expectations. 

"While prices are gradually heating up, growth looks a bit soft, with January retail sales disappointing," Shenfeld notes. "Since the BoC looks at growth as the key factor in medium term inflation, the balance of the news is still sufficient to have Poloz waiting for more news on GDP, although markets today will emphasize the CPI in taking bond yields higher and the Canadian Dollar firmer."

The USD/CAD rate was quoted 0.65% lower at 1.2846 following the release, after extending an earlier 0.08% loss, while the Pound-to-Canadian-Dollar rate dropped to 1.8153 after reversing a 0.05% gain to trade at a 0.49% loss. The Loonie was also quoted higher against all other G10 currencies. 

"USDCAD has traded in a pretty wide range this week, as constructive NAFTA headlines have competed with the free fall in equities. We expect upbeat data from Canada this morning, though we think it will offer only a brief pause in the loonie's recent downtrend," says Mark McCormick, North American head of FX strategy at TD Securities. "We think the 1.28 level offers a hard floor and look for another break of 1.30. For the CAD bulls, we prefer to sell NZDCAD on any good Canadian news."

Inflation and retail statistics matter for the Canadian Dollar because of their implications for Bank of Canada monetary policy. The BoC has raised interest rates three times in the last nine months although, since January, currency markets had become less optimistic about seeing another rate rise anytime soon. 

Interest rate derivatives market pricing on January 17, the day when the BoC last raised rates, implied a 75% chance of another rate rise on April 18. However, this implied probability had fallen to just 24% by 07:50 London time on March 23.

Driving the deterioration of interest rate expectations was a softening of economic data once into the New Year and concerns at the Bank of Canada over the future of the North American Free Trade Agreement.

"Trade policy developments are an important and growing source of uncertainty for the global and Canadian outlooks,” the BoC says, in its March statement.

However, while Friday's data show consumer spending growth also softened in January, the labour market has since recovered from its December blip and inflation pressures are clearly picking up.

In addition, risks to the NAFTA deal may well be diminishing as Thursday saw the Globe and Mail report that the White House has dropped a key but, for Canada and Mexico, contentious demand from its wish list of changes to the agreement. NAFTA, once described as "the worst deal in history" by President Donald Trump, is in the process of being renegotiated under threat of a US withdrawal.

"As you know, we’re renegotiating NAFTA. We’ll see how that turns out...NAFTA has been a very bad deal for the United States, but we’ll make it better or we’ll have to do something else," President Trump told reporters Thursday. 

Nonetheless, it remains to be seen whether any of these recent events will be enough to encourage markets to begin making heavier bets on a rate hike in April again. Some say that they won't.

"The dual reports do little to change the BoC narrative in our view. Inflation is running at target, core inflation is responding to past reductions in slack but growth is disappointing and holding barely above trend. The growth story is more important for near-term BoC expectations and we continue to place higher odds on a July hike vs April, says Brittany Baumann, a macro strategist at TD Securities. "We look to fade the knee-jerk bounce in the the loonie and remain buyers of USDCAD on dips."

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