Canadian Dollar rebounds as US PCE inflation data eases US rate hike bets
- USD/CAD drifts lower to near 1.4190 in Friday’s early European session.
- July Fed hike odds fall to roughly 28.9% from 34.2%, CME FedWatch showed.
- BoC policymakers agreed to keep monetary policy nimble, minutes showed.
The USD/CAD pair declines to around 1.4190 during the early European trading hours on Friday. The US Dollar (USD) softens against the Canadian Dollar (CAD) as the US Personal Consumption Expenditures (PCE) Price Index inflation data eases US rate hike expectations. The Michigan Consumer Sentiment Index report will be the highlight later on Friday.
The headline PCE surged 4.1% YoY in May, marking the first reading above 4.0% since April 2023, but it matched expectations, the US Bureau of Economic Analysis (BEA) reported on Thursday. On a monthly basis, the PCE increased 0.4%, below the market consensus of 0.5%.
Analysts believe that with oil prices falling to pre-war levels on Thursday after the US and Iran signed a preliminary peace deal, inflation likely peaked last month or is close to doing so.
Financial markets have priced in nearly a 28.9% probability that the Fed will raise rates at the central bank's July meeting, down from 34.2% in the prior session, according to the CME FedWatch tool.
The Bank of Canada (BoC) is expected to hold interest rates at current levels for the remainder of this year. Also, minutes from the BoC’s policy meeting did little to reverse a wider gap between US and Canadian interest rates. This, in turn, could cap the upside for the Loonie.
Minutes of the meeting showed that the governing council agreed to keep its monetary policy nimble to respond to new US trade restrictions, the impact of energy prices, or both playing out at the same time. Traders expect 17 basis points (bps) of tightening from the Canadian central bank by December, down from about 60 bps last month, according to Reuters.
Canadian Dollar FAQs
The key factors driving the Canadian Dollar (CAD) are the level of interest rates set by the Bank of Canada (BoC), the price of Oil, Canada’s largest export, the health of its economy, inflation and the Trade Balance, which is the difference between the value of Canada’s exports versus its imports. Other factors include market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – with risk-on being CAD-positive. As its largest trading partner, the health of the US economy is also a key factor influencing the Canadian Dollar.
The Bank of Canada (BoC) has a significant influence on the Canadian Dollar by setting the level of interest rates that banks can lend to one another. This influences the level of interest rates for everyone. The main goal of the BoC is to maintain inflation at 1-3% by adjusting interest rates up or down. Relatively higher interest rates tend to be positive for the CAD. The Bank of Canada can also use quantitative easing and tightening to influence credit conditions, with the former CAD-negative and the latter CAD-positive.
The price of Oil is a key factor impacting the value of the Canadian Dollar. Petroleum is Canada’s biggest export, so Oil price tends to have an immediate impact on the CAD value. Generally, if Oil price rises CAD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Oil falls. Higher Oil prices also tend to result in a greater likelihood of a positive Trade Balance, which is also supportive of the CAD.
While inflation had always traditionally been thought of as a negative factor for a currency since it lowers the value of money, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Higher inflation tends to lead central banks to put up interest rates which attracts more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in Canada’s case is the Canadian Dollar.
Macroeconomic data releases gauge the health of the economy and can have an impact on the Canadian Dollar. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the CAD. A strong economy is good for the Canadian Dollar. Not only does it attract more foreign investment but it may encourage the Bank of Canada to put up interest rates, leading to a stronger currency. If economic data is weak, however, the CAD is likely to fall.
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