Investors will look for clues on whether the rate cut pricing in Canada is unseasonable after the BoC chief claimed that the rate hike cycle may resume if necessary to press inflation to the target. The figures are expected to weaken for the fifth consecutive month on Tuesday at 12:30 GMT, likely creating some extra downside pressure in the Canadian dollar.
Credit conditions
The Bank of Canada (BoC) was the first major central bank to pause monetary tightening in March and maintain interest rates flat since then at 4.5% y/y as concerns over the effects of previous rate hikes mounted after the bank turmoil in the US.
Household debt has been a headache for the Canadian economy before the pandemic and became even more concerning when household-debt-to-disposable income hit a record high at 185.39% in the third quarter of 2022 before inching slightly lower. With real interest rates skyrocketing from 0.25% to 4.50% in just one year, Canada’s financial sector could get closer to a brink given that fixed rates are scheduled to expire earlier in Canada than in other major economies, while its high exposure to the US in terms of exports and commodity prices is adding to the negative risks.
The labor market has been another source of strength for the economy, creating more jobs than expected in March and keeping the unemployment rate steady at record lows for the fourth consecutive month. Strikingly, average wage growth held resilient above 5.0% and higher than inflation.
Of course, the Royal Bank of Canada warned that the mortgage delinquency rate could rise by a third in a year, though as long as the jobs market supports economic growth and inflation stands above the target, the central bank will not cut interest rates as some investors forecast.
CPI inflation estimates
The headline CPI inflation figure is expected to edge lower to 4.1% y/y in April from 4.3% previously – the lowest since August 2021 – , with the monthly reading also inching down to 0.4%. While that could put smiles on policymakers’ faces, especially if the core measures drift lower too, the BoC may need more evidence in the coming months before confirming that inflation will not pivot higher again. According to the BoC’s latest business survey, respondents believe that inflation will stay above 3.0% over the next two years, while the turnup in house prices in Toronto, which persisted for the third consecutive month in April – after a year of declines – raised speculation that inflation expectations may stay elevated.
USD/CAD
Hence, if CPI readings arrive above expectations, questioning the rate cut pricing in markets and signaling that the BoC has still some job to do to achieve its price stability target, the loonie may recoup some of its recent losses. In this case, dollar/loonie could slide back below its 200-day simpe moving average (SMA) at 1.3465 and towards the key 1.3340 support zone. Note that futures markets provide a 36% probability for a rate cut to 4.25% in December.
In the event inflation falls at a faster pace than investors believe, endorsing the central bank’s stance and perhaps making a rate cut more likely in the year ahead, dollar/loonie may re-challenge last week’s tough resistance of 1.3600. A break above that border and beyond April’s bar of 1.3650 is required to lift the price up to the crucial 1.3740-1.3800 constraining zone.
On Friday, retail sales might attract some additional attention even though the data tend to cause little volatility in the loonie. Forecasts point to a 1.4% m/m decline in March, the fastest since September 2022. The measure which excludes automobiles is expected to diminish by -0.8% m/m from -0.7% previously.
A day earlier on Thursday, the BoC Governor and Senior Deputy Governor will hold a press conference to discuss the contents of the Financial System Review—a detailed analysis of developments in the financial system.
