CAD is one of the best performing currencies of 2009 versus the USD. Part of the CAD rally is attributed to Bank of Canada (BOC) policy decision to refrain from quantitative ease. This separates BOC policy from the Fed, BOE, SNB and BOJ. These central banks have adopted varying forms of quantitative ease to boost liquidity and growth. CAD is also supported by global recovery hopes and the recent rally in equity markets and commodities. Risk sentiment and global growth outlook remain the driving factors for the CAD trade. CAD has been weakening lately as the rally in global equity markets and commodities stalls and investors are uncertain about the outlook for the global recovery.
The BOC cut interest rates to record low 0.25% in April and said rates would remain at this level until June of 2010 as long as inflation remains weak. The BOC expects Canada's annual inflation to fall by 0.8% in Q3 and return to the BOC's 2% inflation target by mid 2011. Canada's CPI turned negative for the first time since 1994 in June falling 0.3% y/y. The June CPI decline reflected lower energy prices, in particular weaker gasoline prices. The low Canadian inflation rate encourages the BOC to maintain interest rates at their record low. There is debate about the risk of deflation in Canada but the fact that the price decline is mainly due to gasoline prices suggests that the risk of broad-based deflation appears limited. Canada's CPI is key to BOC policy.
On Wednesday, August 19th Canada will release the July CPI report. July CPI is expected to fall by 0.2% m/m and 0.8% y/y. Core inflation is expected at 0.1% and 1.9% y/y. The impact of the CPI report for CAD should be limited unless the report shows an unexpected rise. Rising Canadian inflation could force the BOC to re-evaluate its record low interest-rate policy. The BOC is expected to refrain from adopting quantitative ease despite weak CPI. A weak Canadian CPI report is not likely to encourage the BOC to reconsider implementing quantitative ease because the BOC expects inflation to rise later in the year as the Canadian economy recovers. CAD price action will continue to maintain a close correlation to risk sentiment, commodity prices and the direction of global equity markets.