USD/CAD rallies after Canadian inflation data cools

• USD/CAD rallies up to higher 1.3500s following lower-than-expected Canadian CPI. 
• The data suggests the Bank of Canada will not need to keep interest rates as elevated – a negative for CAD. 
• Traders gear up for the Fed meeting later on Wednesday. 

The USD/CAD pair continues its rally, reaching the upper 1.3500s on Wednesday, after the release of softer-than-expected inflation data for February gives the Bank of Canada scope to ease policy in the future. 

Easier monetary policy usually means lower interest rates which are negative for a currency as they reduce foreign capital inflows. 

The headline Consumer Price Index (CPI) in Canada rose 2.8% YoY in February, which was below economists’ expectations of 3.1% and the previous month’s 2.9%, according to Statistics Canada. 

Monthly headline CPI rose 0.3% which was below economists’ estimates of 0.6% but above the 0.0% of January.

Canadian Core CPI rose 2.1% in February compared to 2.4% in January. On a monthly basis, Core CPI increased 0.1%, the same as in January. 

The data indicates that the Bank of Canada could tweak its language at the the next meeting in April to sound more dovish, with negative implications for the Canadian Dollar (CAD), but positive for the USD/CAD pair. 

“The 3 mma measures of inflation have softened considerably over the last two months. While an encouraging development that could lead to incrementally more dovish language from the BoC at its upcoming 10-April meeting, we still see hopes for an imminent rate cut as premature.” Says David Doyle, head of economics at Macquarie. 

Fed meeting ahead

USD/CAD is expected to undergo volatility later in the day when the Federal Reserve wraps up its March policy meeting and announces its decisions at 18:00 GMT. 

The Federal Reserve (Fed) is not expected to alter interest rates but there is a chance it could revise its quarterly forecasts and accompanying statement. This could change the outlook for interest rates and therefore the US Dollar (USD) valuation. 

There is increasing speculation that the Fed will revise its economic forecasts in the Summary of Economic Projections (SEP) and the “dot plot”, a chart which reflects the Board of Governors’ consensus expectations of the future path of interest rates. 

In the December SEP, officials forecast three 25 basis points (0.25%) rate cuts in 2024 but some analysts now think there is a risk that this could be revised down to two 25 bps cuts to reflect inflationary pressures remaining elevated. 

Nordea Bank, for example, said in a recent note that, “the Fed will likely need to revise its growth and inflation projections higher for 2024. This could lead to a median FOMC dot plot that shows only two rate cuts this year compared to the latest projection for three rate cuts, made in December 2023.”

Such a move would be positive for USD and USD/CAD, leading to further upside for the pair.