Canadian Dollar Correction To Gather Pace On Sticky Inflation

The Canadian dollar continued to weaken against its U.S. counterpart, with the USDCAD rallying to a fresh monthly high of 1.0062, but we may see the pair consolidate next week as it maintains the range-bounce price action from earlier this year. Indeed, the loonie snapped back on Friday as the ongoing improvement in the labor market spurred increased bets for a rate hike, and the economic developments on tap for the following week may continue to fuel speculation for higher borrowing costs as the recovery gathers pace.

As the headline and core reading for consumer prices are expected to hold steady in April, the stickiness in price growth certainly raises the risk for inflation, and we may see the Bank of Canada continue to strike a hawkish tone for monetary policy as private sector activity picks up. According to Credit Suisse overnight index swaps, market participants see a 25bp rate hike in the next 12-months, but it may only be a one-time deal as the central bank tries to address the record rise in household indebtedness. As Governor Mark Carney continues to highlight the risk generated by the surge in private sector lending, it seems as though the central bank head is making an effort to talk down the rise in household borrowing, but the BoC may have little choice to but to raise the benchmark interest rate from 1.00% as the board raises its fundamental assessment for the economy. In turn, we do not expect to see a series of rate hikes amid the uncertainties surrounding the region, and Governor Carney may revert back to a more balanced tone following a rate hike as external headwinds continue to pose a threat to the recovery.

As the USDCAD maintains the range from earlier this month, we may see the short-term pullback in the exchange rate turn into a larger correction, and we may see the pair fall back towards the 0.9900 to test for interim support. However, should the inflation report top market expectations, a marked rise in interest rate expectations could spur another run at the 0.9800 figure, but we may see the dollar-loonie threaten the sideways price action ahead of the second-half of the year as the BoC is scheduled to meet on June 5th. - DS