Market Brief: Dollar Licks Its Wounds As Inflation Accelerates Slightly in Canada

The dollar is advancing incrementally against its major rivals this morning after suffering extensive losses in the last two weeks on a softening in US economic data and a reversal in bets on Donald Trump’s trade plans. A disappointing payrolls report, several noisy but ultimately calming inflation prints, evidence of a slowing in consumer spending, and a less-aggressive-than-feared reciprocal tariff announcement on Thursday helped bring yields down in the last week and a half, and—despite a small advance overnight—the greenback is now down roughly three quarters of a percentage point in trade-weighted terms.

Canadian headline and core inflation measures accelerated slightly last month even as statistical artifacts related to the government’s general sales tax holiday put downward pressure on some categories. Data released by Statistics Canada this morning showed the Consumer Price Index rising 1.9 percent on a year-over-year basis in January, up from the 1.8-percent increase recorded in December, but in close alignment with consensus expectations. On a month-over-month basis, prices rose 0.1 percent after a -0.4-percent drop in the prior month. Core inflation, computed as the average of the two price measures now preferred by the Bank of Canada (trim and median), increased 2.7 percent over the same period last year, up from 2.55 in the prior month. Statisticians noted that the Liberal government’s sales tax holiday helped lower food, alcohol, and toy prices—as intended—but this was partially offset by a 5.3-percent rise in energy prices relative to last January’s levels.

We think the Bank of Canada is still likely to deliver a rate cut in March or April. Survey data suggests that consumers and businesses have turned more cautious in the last month—compounding already-weak spending and investment levels—and with shelter prices excluded, underlying inflation measures remain well below target, giving policymakers plenty of room to move rates closer to “neutral”. We would slightly favour the April meeting—given that the Bank’s next Monetary Policy Report is set for release then—but renewed trade rhetoric from the Trump administration in the coming weeks could easily tilt the odds back toward March.

The British pound is staging a mild recovery against the dollar as traders pull back on easing bets in the aftermath of a stronger-than-anticipated employment report. According to data released by the UK Office for National Statistics this morning, growth in wages excluding bonuses accelerated to 5.9 percent in the final quarter of 2024, reaching an eight-month high and giving policymakers at the Bank of England reason to tread cautiously as they work to bring inflation down. Swap traders expect two additional rate cuts to come this year as stagflationary conditions continue to restrict the Bank’s room for manoeuvre.

Across the Channel, the euro is turning in a similar performance after the German ZEW* Institute said its economic sentiment index jumped 15.7 basis points to 26.0 in February, posting its strongest performance in two years as investors turned more optimistic ahead of this weekend’s national elections. With Christian Democrat leader Friedrich Merz—who has campaigned on a platform dedicated to cutting taxes, lowering energy costs and reducing bureaucracy—ahead in the polls against Olaf Scholz, defence spending set to rise, and a growing share of the population favouring reforming the much-maligned fiscal “debt brake” to support more public investment, business leaders are growing hopeful that the country could be on the verge of a modest recovery.

This week’s economic data calendar looks remarkably quiet. The UK will publish its latest consumer price index update tomorrow morning, helping traders calibrate easing expectations. Minutes taken during the Federal Reserve’s January meeting will be released later in the day, but could be light on market-moving material, given that economic risks continued to move into greater balance ahead of the discussion, and the second Trump administration’s changes to trade, immigration, fiscal, and regulatory policies were yet to come. Global purchasing manager indices due ahead of the weekend could deliver insight into how a still-rhetorical trade war is impacting sentiment among businesses in the world’s biggest economies.

In currency markets more broadly, implied volatility has fallen sharply from its early-February highs. After a series of reversals, climbdowns, and largely-meaningless policy shifts, markets have concluded that Donald Trump’s trade threats are unlikely to reach full implementation. It may be that even if the president believes in the redemptory power of tariffs, other members of the administration understand the potential for damage to the US economy and are working behind the scenes to frustrate his ambitions.

This state of calm is unlikely to last. With a number of important deadlines—including the March 4 expiration of a delay in tariffs against Canada and Mexico, and the April 1 and 30 delivery dates for reports from federal agencies on the "America First Trade Policy"—looming ahead, it is reasonable to assume that new shocks are in the offing. Rallies in currencies exposed to the president’s ire—including the Canadian dollar, Mexican peso, and euro—should be regarded with suspicion for now, even if American threats ultimately translate into an improvement in each region’s domestic political economy**.

*We'd spell this one out for you, but it contains some of those super-long German words that, when spoken, can make a person sound like they're suffering from respiratory distress. Okay, fine, here it is: Zentrum für Europäische Wirtschaftsforschung

**A case is building for a recovery outside the US as governments are forced to increase defence spending and reform their own economies, but politicians rarely miss an opportunity to miss an opportunity, so the jury is still out on whether this translates into reality.

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