Will Canadian CPI Inflation Revive Loonie Bulls?

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September’s CPI inflation prints will be closely watched in Canada on Wednesday at 12:30 GMT. Analysts estimate a third consecutive month of diminishing inflation, but that might not necessarily be enough to push additional rate hikes out of scope. Retail sales will be the next highlight on the calendar on Friday, but don’t expect any fireworks here either.

Inflation to ease but stay uncomfortably high

The Bank of Canada has raised interest rates incredibly fast by 300bps since March and perhaps the latest softening in inflation data could be a product of its aggressive tightening. However, despite the fast pace and size of monetary tightening, the impact on inflation has been negligible so far and the BoC’s 1-3% target remains some distance away, raising fears of an entrenched inflation phenomenon.

The headline CPI is expected to ease to 6.8% y/y in September from 7.0% previously and 8.1% in July. However, the BoC chief Tiff Macklem has already clearly dismissed any pivot scenarios, reinstating the central bank’s objective of cooling inflation towards its 1-3% range target, even if concerns are mounting for a recession next year.

How big will the next rate hike be?

The central bank’s latest business survey for the third quarter added to the above worries on Monday, showing the biggest contraction in business sentiment since the pandemic and weakening demand forces, especially in the housing market. Even more striking was the fact that inflation expectations remained elevated despite softening a bit. Hence, with consumers and businesses remaining uncomfortable with the inflation picture, the BoC will probably deliver another rate hike at its next policy meeting on October 26.

The next question that arises is how big the next rate hike will be. Futures markets are currently foreseeing a smaller 50bps rate hike for October and a similar action for December, which might reflect a careful consideration of the household debt burden. The outlook for 2023 is rather uncertain amid fears of a potential economic slowdown, with analysts seeing just a modest rate increase at the start of the year.

What could revive loonie bulls?

Yet, an upside surprise in the CPI data, and more importantly in the core measures, could easily delay an anticipated slowdown in the pace of rate increases, likely bringing the case for a 75bps rate hike back on the radar. Consequently, with the US dollar lacking any fresh impetus so far this week, the loonie could recoup some lost ground. Specifically, dollar/loonie could head for the 1.3600 level. However, a move below 1.3500 could be more meaningful in terms of changing the market trend.

Otherwise, a weaker than expected inflation print could barely affect the BoC’s policy decision, leaving the loonie unaffected near its recent lows against the greenback. Retail sales for August, although expected to recover a large part of July’s significant decline on Friday, may also prove insufficient to boost the loonie as long as the labor market keeps supporting consumption.