On Tuesday, the CAD was able to gain slightly against the USD. This happened despite the fact that inflation never stopped climbing in Canada. In April, the Headline Consumer Price Index (CPI) inflation increased to 1.7% year-on-year. That was a drop from September’s 2.3%—the first positive reading in six months—but it still beat analysts’ estimates. This pairing of accelerating inflation and a slight rebound in the CAD presents another layer of complication to the economic picture.
The CAD climbed by just over a sixth of a percent against the USD. This increase is a 0.7% improvement over its lows set last week. While this increase certainly gives the Loonie a short-term surge, it is still down against the USD in recent weeks. Here are three of the most important factors that determine the Canadian Dollar’s value. Broadly, interest rates, oil prices, and economic health play a huge role in its dynamics.
Inflation Rates and Economic Indicators
April’s inflation data shocked the market with a shocking increase in core CPI measures. This points to continued inflationary pressures that are disappointing and not letting up. Against that backdrop, the BoC core CPI shot up to 0.5% m/m in April. This jarring jump is a far cry from March’s paltry 0.1% increase. Together, these numbers confirm the trend of rising inflation once again. This trend increases the stakes for how effective monetary policy can hope to be in stabilizing prices.
The consumer effects of this surging inflation go further than just a scary headline statistic. Inflation erodes consumer purchasing power and economic stability. Instead, housing prices continue to rise. For all the efforts the BoC has made to improve affordability through cuts in interest rates, it hasn’t yet had the intended effect. This unfortunate reality leads us to wonder how effective, if at all, current monetary policy is working. Can it actually address inflation while continuing to promote strong economic growth?
Factors Influencing the Canadian Dollar
Several essential factors are fueling the appreciation of the CAD, an interest rate determined by the BoC being the most important. The central bank’s interest rate decisions play a large role in shaping market sentiment and currency value. In general, increased interest rates are supposed to draw inflows of foreign capital, supporting the currency, while lower interest rates work in the direction of depreciation.
Additionally, oil prices—Canada’s largest export—hold a critical sway over the CAD’s performance. So, just as temporary spikes in petroleum prices are making headlines, so is the relative value of the Loonie. Recent rises in oil prices have provided support to the CAD. In the wake of all these efforts, it has been able to rebound some against the USD. Yet lasting appreciation in this currency’s value will require ongoing increases in oil prices to meet any durable economic turnaround.
Rebalancing of trade balance is very crucial for CAD’s trajectory. The difference between Canada’s exports and imports directly affects currency strength. A favorable trade balance generally supports a stronger CAD. A trade deficit can cause currency depreciation. As Canada continues to feel the impact of an uncertain economic landscape, a positive overall trade balance will continue to be key for supporting the CAD.
Economic Health and Future Outlook
The overall health of Canada’s economy is another significant determinant of the CAD’s value. Let’s look at some of the key economic indicators, like GDP growth, employment rates, and consumer confidence—which all combine to create vital market perceptions. Though recent economic indicators point to a robust recovery for Canada, led by commodities, some of these perils have already begun to strike.
The health of the US economy is just as important, since it’s Canada’s biggest customer. Shifts in US economic performance lead to immediate spillover effects in Canada which drastically change the trade landscape and are suggested to influence Canadian dollar valuation. With both countries being challenged by inflationary pressures and changing global economies, their connectedness has never been more apparent.
Though the recent CAD reality is a welcome short-term improvement, analysts warn of continuing major headwinds. The recent rise in inflation may prompt further scrutiny of monetary policy and could impact future interest rate decisions by the BoC. The future path of oil prices will play an important role in determining how long these gains last. Watch oil trends to see what they do in the long-run!