A Look at the Canadian Economy

Apr.23.10 | About: CurrencyShares Canadian (FXC)
Canadian CPI figures for March were tamer than the market expected and this should help take ease what we thought had been an over-reaction to recent official statements.

Headline inflation slipped 0.2% on the month. The market had looked for a fall report. The year-over-year rate eased to 1.4% from 1.6%. More importantly from a policy point of view, the core rate fell 0.2% and eased to 1.7% year-over-year from 2.1%.

The market took the dropping of the conditional pledge to keep rates steady as a sign that a hike would come at the next meeting on June 1 and some suggested a 50 bp rate was likely. The Bank of Canada also indicated that the Jan-Feb rise in price pressures were partly a result of transitory phenomenon related to the Winter Olympics. Sure enough, traveler accommodations fell 14% in March offsetting a good part of the earlier run-up.

Price pressure in Canada are expected to rise more gradually as the economy recovers. Canadian businesses typically under-invest in capital equipment and this generate lower productivity growth, which in turn means that Canada often experiences inflation earlier on its business cycle.

To be sure, we still think that the underlying fundamentals for Canada are constructive and we continue to expect the Bank of Canada to hike rates well before the Federal Reserve. Indeed the BOC is likely to be the first G7 central bank to hike rates. Our concern is about the near-term and, what we suspect, was a market over-reaction. If the greenback can establish a foothold above CAD1.0040, there is potential toward CAD1.01 initially. A move above there would suggest a more extended correction that could see a move into the CAD1.02-CAD1.03 area.

At the same time, CAD/USD is not in a vacuum and the general direction of the US dollar is also important. If the EU/IMF package does not satisfy the markets and renewed euro selling is seen, then it could disrupt moves in the Canadian dollar. We note that often in when the US dollar is bid, the Canadian dollar often fares better on the crosses against Europe. On the other hand, during periods of heightened risk aversion, especially if commodity prices soften, the Canadian dollar may weaken against the greenback and yen.

Disclosure: No positions