The outlook for the CAD is closely linked to the outlook for the global economy, commodity prices and Bank of Canada (BOC) policy. BOC policy remains focused on Canada's domestic growth and inflation outlook. CAD has been supported by the BOC decision to maintain steady rate policy and refrain from implementation of quantitative ease. The BOC elected to hold a policy steady at 0.25% last week, refrain from implementation of quantitative ease and reaffirmed a pledge to keep interest rates at all 0.25% through mid-2010 provided inflation remains in check. Canadian inflation pressures remain subdued.
Canada's July annual CPI declined the most since 1953 reported at -0.9%. The CPI decline primarily reflected a 23.4% drop in energy prices, in particular a sharp decline in gas prices. Of the other components of the CPI, transportation, shelter, clothing and footwear were lower along with natural gas and homeowner replacement costs. The only upward pressure on CPI came from food prices. On September 17th, Canada's August CPI will be released. The August CPI is expected at 0.1% m/m compared to -0.3% in July. August core CPI is expected to rise by 0.1% compared to a flat reading last month.
At the September BOC policy meeting, BOC board members said that they see the start of recovery in the Canadian and global economy. Canada's GDP turned positive for the first time in ten months in June rising by 0.1%. The GDP rise suggests that Canada's recession is ending. The BOC board members also expressed concern that the strength of the CAD may choke off the economic recovery. The August CPI report is unlikely to alter the outlook for steady BOC policy and should have limited impact on CAD trade unless Canadian inflation begins to rise rapidly. A rapid rise in Canadian inflation could force the BOC to shorten its time horizon for maintaining overnight interest rates at a record low 0.25% and abandon its pledge to hold rates steady until mid 2010. BOC targets a 2% inflation rate and spare capacity in the economy will limit inflation pressures. CAD may trade near parity versus USD in the months ahead supported by rising commodity prices as the global economy recovers and the BOC maintains steady rate policy. Uncertainty about the strength of the global recovery and risk of intervention are the main risks to the CAD.