The loonie lost value against the greenback as measured by USDCAD. This decrease was largely a result of mixed inflationary indicators and a declining US dollar. In December, Canada’s core Consumer Price Index (CPI) came down to 2.8% – a slight dip from 2.9% the month before. This shift in data has raised concerns regarding the implications for monetary policy, especially as the Bank of Canada (BoC) sets a core CPI target of 2%. Core inflation figures are watched closely by economists, as they reflect the underlying price trends that central banks are trying to rein in.
The new inflation numbers tell a complicated story. Monthly price pressures are starting to cool off, but annual inflation remains persistently above the Bank of Canada’s target. Recent US inflation figures have been climbing, up to 2.4% in December from 2.2% in the month before. This increase was more than most market predictions had anticipated and added further complexity. As a major crude exporter, Canada’s economy is affected by global oil prices, which have provided some support to the Canadian dollar amidst fluctuating inflation data.
Understanding Core CPI Trends
Core CPI, which excludes volatile items like food and energy prices, is a major economic measure closely watched by the Federal Reserve. It acts as a truer gauge of inflation and is the target of economists and policymakers on both sides of the aisle. In Canada, the BoC targets a core CPI inflation rate of around 2%. Every time core CPI crosses above their 2% target, they raise the Fed Funds rate. In this hypothetical, the independent central bank has a strong inflation aversion and moves aggressively to quell inflationary pressure. On the other hand, when core CPI dips below 2%, it makes a case for lowering interest rates in order to spur economic growth.
Perhaps the recent easing in Canada’s core CPI, from 2.9% down to 2.8%, already reflects this easing in inflationary pressure. Nonetheless, this drop is not enough to bring core inflation below the BoC’s target. The mixed results highlight a complex economic landscape where inflation is not uniformly declining, leading to uncertainties about future interest rate decisions.
In Canada, we calculate our headline inflation as a year-over-year percentage change. Both month-on-month (MoM) and year-on-year (YoY) changes in this measurement are calculated. Specifically, the stability of headline inflation is key in shaping how the public understands—and expects—price stability to behave. It further distorts consumer behavior and their perception of economic health.
The Impact of U.S. Inflation on Canadian Markets
Given how Canada’s inflation is still looking pretty mixed, the contrast with U.S. inflation provides a whole different level of complexity to this economic outlook. The U.S. CPI accelerated to 2.4% in December, prompting discussions about potential shifts in monetary policy from the U.S. Federal Reserve. When U.S. inflation is higher than what the markets were expecting, it increases demand for the U.S. dollar. This sudden change in demand has a strong impact on currency pairs like USD/CAD.
The strong correlation between key U.S. economic indicators and Canadian markets highlights the increasingly interconnected nature of North American economies. A stronger U.S. dollar often results in downward pressure on the Canadian dollar, particularly given Canada’s reliance on exports, including crude oil. Consequently, changes in U.S. inflation can have big impacts on exchange rates and market expectations.
Outside of the mixed inflation data, the anchor of steady oil prices have given some modest support to the Loonie. West Texas Intermediate (WTI) crude oil traded was up slightly on the day at $59.15, an increase of 0.20% on the day. Canada is the single largest source of crude oil imports to the U.S. Falling oil prices can offset much of the damage done by disappointing inflation data.
Looking Ahead: Implications for Monetary Policy
The new changes in the core and headline CPI numbers in Canada raise very important questions. They will have lasting impact on future monetary policy decisions from the Bank of Canada. Economists emphasize that maintaining inflation around the 2% target is essential for economic stability and growth. Should core CPI continue to stay above the BoC’s target, the bank will be required to increase monetary policy. This unprecedented move is intended to tackle escalating costs.
If core CPI were to fall below 2%, this could open avenues for potential interest rate cuts aimed at stimulating economic activity. The oftentimes precarious balancing act between subduing inflation and promoting economic expansion continues to occupy center stage in the minds of monetary policymakers.
As Canada navigates these economic challenges, stakeholders will closely monitor both domestic and international indicators that may influence market dynamics. As uncertainty continues with respect to U.S. inflation and rising global oil prices, the impacts on Canada’s economy and currency are consequential.