The Canadian dollar has had a strong beginning of the week. That makes sense considering on Friday we had a stronger-than-expected release for September's consumer prices. As we know inflation is the key measuring stick for monetary policy and the data would suggest that the Bank of Canada should not be so quick to give up any tightening bias.

Factors Helping to Drive CAD Strength

The Canadian dollar moves in conjunction with expectations for global growth and for the growth of its largest trading partner the United States. The data from the US has improved of late and this week we're expecting to see the US posting third quarter annualized growth of 2.7%, a nice improvement on the paltry 1.3% pace set in the 2nd quarter.

We also saw data from China to start the week which showed that its manufacturing sector is expected to grow in October for the first time in four months. That has created increased demand for riskier assets and the Canadian dollar has been one of those benefactors.


Canada is a very large exporter of oil and oil prices have been rallying strongly this month as well, helping to put some wind behind the Canadian dollars sales. Crude oil prices moved to $94.50, the highest they have been since early August, with the next level of clear horizontal resistance above the $100 level.

We therefore have a combination of better global growth prospects which is boosting oil prices and Canadian fundamental macro data pointing to strength as well.

One other factor worth noting is that the Canada debt is still considered a true AAA as the country's banking system was not over leveraged and did not have to be rescued by government action. Therefore, as the Euro-zone debt problems loom large, and the US struggles with its debt position, those seeking AAA investments have a limited universe at this point to choose from. Inflows to buy the safe Canadian debt therefore should help drive CAD-positive medium-term flows.

Canadian Retail Sales

In today's action prior to the bank of Canada it interest-rate statement which week over below we saw Canada's retail sales rise 0.5% in August compared to July. While that data is a bit dated it still shows a bounce back in consumer spending in the middle of the third quarter. If we take away auto sales or the core retail sales number was up 0.4%. Week it comes sales of motor vehicles ratcheted down during the month stronger spending by Canadian consumers is a positive for growth, adding another piece of data to the data stream which supports the recent moves in the Canadian dollar.

Bank of Canada's Assessment

The one thing that could clip the Canadian dollars sails would be a dovish central bank and today we do get an updated statement from the Bank of Canada.

We previewed the bank of Canada interest-rate statement here.

In it we see the central bank showing concern about the global economy but also the outlook for the Canadian economy which has weakened since July.

Although Canadian growth rebounded in the third quarter with the unwinding of temporary factors, underlying economic momentum has slowed and is expected to remain modest through the middle of next year.

Overall, the Bank expects that growth in Canada will be slow through mid-2012 before picking up as the global economic environment improves, uncertainty dissipates and confidence increases. The Bank projects that the economy will expand by 2.1 per cent in 2011, 1.9 per cent in 2012, and 2.9 per cent in 2013.

On the inflation front the weaker outlook for growth meant that there is weaker expectation for inflation.

As a result, core inflation is expected to be slightly softer than previously expected, declining through 2012 before returning to 2 percent by the end of 2013. The projection for total CPI inflation has also been revised down, reflecting the recent reversal of earlier sharp increases in world energy prices as well as modestly weaker core inflation. Total CPI inflation is expected to trough around 1 per cent by the middle of 2012 before rising with core inflation to the two per cent target by the end of 2013, as excess supply in the economy is slowly absorbed.

The bank certainly seems to have ignored the jump inflation we saw on Friday and is looking at to the medium-term where it sees inflation weaker than in its previous estimates, which should weigh on the Canadian dollar from a fundamental perspective.

With the target interest rate near historic lows and the financial system functioning well, there is considerable monetary policy stimulus in Canada.

The USD/CAD responded by climbing to its intraday high following the release breaking back above 1.0070 after having been at the parity level just prior to the central bank's statement.

- Nick Nasad is the Chief Market Analyst at FXTimes - provider of Forex News, Analysis, Education, Videos, Charts, and other trading resources.