Canadian dollar bounces back above 71 cents U.S. on weaker stateside inflation

The increasing possibility that the interest rate differential between Canada and the U.S. could tighten or at least not widen is helping the loonie. Photo by Peter J. Thompson/Postmedia

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U.S. inflation for June came in at 3.5 per cent year over year, beating economists’ expectations of 3.8 per cent and down from the 4.2 per cent increase recorded in May. The core measure was flat month over month versus calls for it to rise to 0.2 per cent.

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“That has put a substantial damper on the dollar, seeing the U.S. dollar index fall sharply post-release as traders pare back Fed hiking bets for the second half of the year,” Nick Rees, head of macro research at Monex Deposit Co., said in a note.

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Bets for the U.S. Federal Reserve to hike interest rates in July have now fallen to 10 per cent from about 40 per cent on Monday. Bets for rate hikes further into the last half of the year were also pared back.

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In response, the U.S. dollar index, which measures the greenback against a basket of other major currencies, including the Canadian dollar, lost about 0.5 per cent Tuesday.

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“This data is, without a doubt, unambiguously dovish for the Fed,” Rees said.

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Investors have been flocking to the U.S. dollar for safety as the U.S.-Iran conflict continues, but they were also drawn by the higher Fed rate compared to other central bank rates, including the Bank of Canada’s, and the prospect of hikes to come this year.

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Canada’s overnight lending rate stands at 2.25 per cent, while the Fed’s target rate sits at 3.75 per cent at the upper bound.

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The increasing possibility that the interest rate differential between Canada and the U.S. could tighten or at least not widen is helping the loonie.

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The Canadian dollar is up 1.25 per cent from June 24 after it dove 4.6 per cent starting in May and just averted falling below 70 cents U.S.

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On one hand, the drop in gasoline prices recorded in June looks dated as hostilities reignite between Iran and the U.S., bringing tanker traffic in the Strait of Hormuz to a near standstill.

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On the other hand, there were signs of pricing relief in some areas, including clothing, used cars and shelter, suggesting a “general easing of inflation pressures,” while the unwinding of the effects of tariffs helped with the prices of goods, Rees said.

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Monex continues to call for the Fed to hold interest rates through 2026, assuming Middle East tensions cool, posing a “downside risk” for the U.S. dollar.

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