The CAD/USD pair has been within a distinct downtrend for the third consecutive week. In early September, the USD/CAD pair reached a six-month price high, approaching the 1.3700 level. However, sellers took control, pulling the price down to the current level of 1.3420. The pair moved by more than 250 pips, while ignoring the greenback's broad strength. This indicates that the Canadian dollar has been the driving force behind the downward movement, strengthening its position thanks to a favorable fundamental background.
Recall that after the last Bank of Canada meeting, the central bank did not announce an interest rate hike but noted that it did not rule out such a scenario. The Bank of Canada's statements were somewhat cautious, but at the same time, the central bank suggested that inflation could show an uptrend in the near future due to rising gasoline prices.
The central bank's concerns, to a large extent, have been justified. Canada's annual inflation rate jumped in August, data showed on Tuesday.
Canada's annual inflation rate rose to 4.0% in August on year-over-year, surpassing expectations of 3.8%. This indicator has shown an uptrend for the second consecutive month. Moreover, the index jumped from 3.3% to 4%. The core Consumer Price Index, which excludes volatile energy and food prices, also increased. Canadian annual core inflation ticked up to 3.3% in August 2023. Although it was just a slight increase, the fact that it grew says a lot. The core index had been consistently declining for seven months, from November 2022 to June 2023, reaching 3.2% in June. In July, it remained at the same level, but in August, it slightly accelerated, the first time since October 2022.
The structure of the report indicates that the acceleration in inflation is primarily driven by the increase in gasoline prices. Other components have also risen: food prices increased by 6.8% year-on-year, clothing and footwear prices increased by 1.7% year-on-year, and transportation services became more expensive by 2.3% year-on-year. Housing prices in the past month increased by 6.0% after a 5.1% rise in July (partly due to rising rental rates and increased interest rates).
Overall, considering the dynamics in August, we can assume that Q3 inflation will be higher than what the Bank of Canada forecasted at its July meeting. This is bad news for the Canadian central bank, which, judging by its rhetoric after the September meeting, seems inclined to maintain a wait-and-see stance.
In response to this report, the USD/CAD pair dropped to the support level at 1.3380 (the upper band of the Kumo cloud on the daily chart). Although buyers were able to recover some of the lost positions afterward, the sentiment remains bearish.
The next Bank of Canada meeting is scheduled for October 25th, by which time the central bank will have both inflation reports for August and September. If the September CPI report follows the trajectory of August, the likelihood of another interest rate hike will significantly increase. When making the decision on interest rates in September, the head of the Canadian central bank explicitly stated that the Bank could raise borrowing costs again "if inflationary pressures persist." Therefore, if the growth dynamics persist in September, the Bank may resort to further measures in October.
Such a scenario is quite likely, given the current situation in the oil market. Despite the price pullback, Brent and WTI continue to hover around multi-month price highs, thus fueling the spiral of inflationary growth.
Therefore, the latest inflation report supported the Canadian dollar. Although the fundamental picture remained the same - the next meeting of the Bank of Canada will be held five weeks from now.
However, the rise in inflation figures amid increasing oil prices creates a favorable environment for the progress of the downtrend in the USD/CAD pair, with one condition - if the Federal Reserve, after its September meeting, does not boost the U.S. dollar with its hawkish rhetoric. If the greenback does not receive support from the Fed, sellers can count on a retest of the support level of 1.3380 (upper band of the Kumo cloud on the daily chart). Breaking this price barrier will open the path to the 1.3300 level, which is the lower band of the same cloud on the same timeframe. Nevertheless, considering the risks mentioned above, it is advisable to maintain a wait-and-see position until the results of the Fed meeting are announced.
