Forex Investment and Currency Trading

The Current Situation
Seeming Immunity: Both headline and core inflation measures rose in April, but remained below target despite rising global relative pricing pressures. Canada’s seeming immunity thus far stems from the strong CAD’s lowering of import prices for most non-food and -energy goods (Figure 3), and from slower home price appreciation (Figure 4). The dampening effect of drastic price-tag reductions and incentives from retailers late last year, and the 1% cut in the Goods and Services tax this year, have also helped to shield Canadians from external inflationary pressures.

Limited Pricing Power: Producers are feeling the pinch of higher input costs, and some have expressed a desire to pass on these costs to consumers (see Figure 5). (The CPI for food and energy popped up to 3.6% y/y in April after dipping to 2.1% in March, and could march higher if rapid commodity price increases persist.) However, we doubt that they will have much success in lifting core goods prices, especially since many retailers understand from last fall’s experience, that Canadians will respond to higher prices for discretionary items with their feet. The stalled Canadian expansion and consumer sensitivity to pricing differentials between identical domestic and U.S. goods, affords limited pricing power for businesses.

What’s Next?
Inflation Outlook: On balance, core consumer inflation should remain below the Bank of Canada’s 2% target through the summer, though food and energy could place upward pressure on the overall measure. Some anticipated depreciation of the CAD versus the USD later this year, and the gradual phase-out of last year’s price cuts, should cause both headline and core CPIs to move back towards target by yearend (see Figure 6). Market anticipates that inflation will remain relatively benign over the medium term.

Key Risks : Upside risks to the inflation outlook continue to include stronger-than-expected domestic demand growth, slower productivity and possible spillover of higher global food and energy prices to Canada (see Figure 7). Main downside risks include stymied exports growth amid tepid U.S. domestic demand, tougher lending standards and liquidity pressures, the dampening effects of past CAD appreciation, and reduced commodity demand and prices on profits (see Figure 8).

Policy Implications : The persistence and preponderance of downside risks near term and tethered
inflation, likely will prompt an additional 25 basis point rate cut in June. However, the BoC’s cumulative 175 basis points of easing and continual engagement in Term Purchase and Repurchase Agreement transactions to date, signal a pause at 2.75% following the June meeting. Barring a meaningful intensification of downside risks or relapse of severe financial market weakness, it is believed this is the likely course. Moreover, flagging output and a benign core inflation outlook should dampen expectations of a rate hike this year or early next.