Could Canada's inflation produce a downside surprise? – Preview 

Nov 17, 2023 at 9:47 am GMT- Achilleas Georgolopoulos

• BoC’s hawkishness depends on stronger inflation prints

• The October inflation report is expected on Tuesday at 15:30 GMT

• Aussie could get a short-term boost next week against the US dollar

BoC was really worried about inflation at the October meeting

At its October 25 meeting, the Bank of Canada held its main policy rate unchanged at 5%. Despite acknowledging the impact of higher rates on the real economy, the BoC's Governing Council once again expressed its readiness for further rate hikes “if needed" at the meeting’s statement. In addition, Governor Macklem did not scale back his hawkishness at the press conference, stating that "inflation is on a higher path than expected." This meeting’s overall hawkish stance was eventually confirmed by the minutes, published a fortnight after the official gathering, revealing that the BoC members were very worried about inflation.

Heightened geopolitical risks impacted the meeting

The last meeting took place during a tumultuous period with the Middle East developments escalating and fueling worries about a wider, regional conflict in this region, and therefore affecting the overall rhetoric from the BoC. Consequently, the quarterly BoC projections for inflation were upgraded for both 2024 and 2025. However, the input data used for these calculations were taken when oil prices were moving higher due to heightened geopolitical risks.

As seen, these concerns were not confirmed, as oil prices dropped aggressively to the mid-70s, thus allowing central banks around the world to breathe a sigh of relief. This, of course, does not mean that the inflation threat has been extinguished, but the central banks are clearly assigning a lower probability to a repeat of the considerable rally in commodity prices seen in 2022.

Market looking for rate cuts in 2024

The market is gradually pricing rate cuts for 2024, in line with the Fed expectations. At the moment, 75bps of rate cuts are expected by end-2024 for the BoC with some investment houses being even more aggressive in their forecasts, partly due to the recent mixed data releases, with only the housing sector continuing to surprise BoC officials with its resilience. With the next meeting scheduled for December 6, next week’s data prints are a key piece of the jigsaw.

Inflation in the foreground

In this context, on Tuesday we will get the inflation report for October. Globally, we have seen a very strong deceleration in the October CPI figures. For example, the annual headline inflation in the UK dropped to 4.6% from 6.7% in the previous month. Similarly, the US CPI print also slowed a bit, thus opening the door to Canadian inflation edging lower and potentially canceling out a decent part of the upmove recording since July 2023.

The Canadian statistics agency in cooperation with the BoC have created a plethora of core CPI measures, but the overall trend is the key. And these various core inflation measures appear to have found a floor over the past three months, thus justifying the Governor’s Macklem comment, following the October meeting, that they need to see a “clear downward momentum in core inflation”. Interestingly, the real strength of consumer demand will be seen in Friday’s retail sales release, especially as earnings remain elevated and above their long-term average.

Loonie shows signs of recovery

Loonie bulls have been trying to stage a strong sell-off in the US dollar/loonie pair after the new 2023 high of 1.3898 was recorded on November 1. However, their efforts halted twice at the 50-day simple moving average.

A strong set of inflation and retail sales figures next week could potentially allow loonie bulls to overcome the key 1.3665 level. However, this move could prove short-lived, especially if the market starts to price in an even more aggressive removal of monetary tightening during 2024 by the BoC.

On the flip side, a combination of downside surprises at next week’s data releases will probably help dollar/loonie to drift effortlessly above the 1.3807 area, and possibly then flirt with the recent 2023 high.