Canadian Dollar: Higher Inflation To Support Speculation For Rate Hike

Fundamental Forecast for Canadian Dollar: Neutral

- Canadian Dollar Benefits From Risk Appetite
- Canadian Dollar Finding Support Despite Declining Oil Prices
- Risk Appetite and Volatility for Broader Markets Temporarily Dormant not Permanently Restrained

The Canadian Dollar pared the four-day rally as investors scaled back their appetite for risk, and the currency is likely to face increased volatility over the following week as the economic docket is expected to reinforce and improved outlook for growth and inflation. At the same time, investors are pricing a 68% chance for a 25bp rate hike by the Bank of Canada next month according to Credit Suisse overnight index swaps, and expect the central bank to raise borrowing costs by nearly 170bp over the next 12-months as policy makers see 2010 as "the turning point when private sector demand takes over from the public sector as the primary source of growth."

The BoC has shown an increased willingness to normalize policy further this year as the central bank sees the growth rate expanding 3.7% in 2010 amid an initial projection for a 2.9% rise in GDP, and higher inflation accompanying the rebound in economic activity will certainly give the governing board scope to raise borrowing costs as it aims to balance the risks for the economy. Consumer prices are anticipated to rise 0.2% in April after unexpectedly holding flat in the previous month, while the headline reading for inflation is expected to rebound to 1.7% after slipping to an annualized pace of 1.4% in March. In addition, the core rate of inflation is projected to tip 0.1% higher during the same period after contracting 0.2% in the month prior, with prices excluding volatile items such oil and transportation costs forecasted to increase 1.8% from the previous year, and mounting price pressures could add to expectations for a rate hike in May as inflation approaches the 2% target.

However, retail spending is expected to hold flat in April despite the record jump in employment, while demands for Canadian securities is expected to grow at a slower pace in March, and the data could lead the BoC to hold a neutral policy stance next month as the marked appreciation in the exchange rate continues to drag on the economic rebound. Nevertheless, as risk trends continue to dictate price action in the currency market, uncertainties surrounding the global outlook may continue to weigh on risk sentiment and push the Canadian dollar lower against the greenback as its U.S. counterpart benefits from safe-haven flows.

DailyFX provides forex news on the economic reports and political events that influence the forex market.