Inflation in Canada is forecast to moderate in January due to lower food and fuel prices

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• Canada's consumer price index is expected to rise 3.3% year over year in January.
• Canada's CPI inflation data is set to influence the timing of a Bank of Canada rate cut.
• Statistics Canada will release CPI inflation data on Tuesday.

High impact consumer Price index Data (CPI) from Canada will be released by Statistics Canada at 13:30 GMT on Tuesday. CPI inflation data is likely to have a significant effect on the market price of the expected Bank of Canada (BoC) interest rate cut this year, which will affect the value of the Canadian dollar.

What to expect from Canada's inflation rate?

Economists expect Canada's CPI to grow at an annual rate of 3.3% in January, slowing from the 3.4% recorded in December. On a monthly basis, CPI inflation rebounded to 0.4% in the same period after a 0.3% decline in December. Core CPI rose 0.1% month-on-month in December.

Alongside the CPI data, the Bank of Canada (BoC) will release its closely watched Core Consumer Price Index data, which excludes volatile items such as food and energy prices. Annual BoC Core CPI rose 2.6% in December, while monthly BoC Core CPI fell 0.5%.

The expected slowdown in overall Canadian year-over-year CPI inflation can be attributed to lower energy and food prices. Core CPI figures are likely to remain flat, however, in the face of higher BoC borrowing costs that have led to higher mortgage interest costs and rents.

Analysts at TD Securities (TDS) noted in a preview of the Canadian inflation report: “We expect headline CPI to fall 0.2 pp to 3.2% y/y in January as prices rise 0.4% m/m , but details should support limited progress. Food/energy components will drive most of the slowdown as 3m core CPI rates accelerate from December. This should result in a mixed tone overall, with persistent core inflation setting the bar high for any dovish move from the BoC in March.”

According to Canada's overnight index swap (OIS) curve, July is likely to see a first-rate tapering from the BoC.

Bank of Canada Governor Tiff Macklem told a meeting of the Council on Foreign Relations in Montreal last week that “the policy debate is shifting from whether or not policy is restrictive enough to how long it should remain restrictive.

“The path back to 2.0% inflation is likely to be slow,” Mackem said, warning that “risks remain as shelter prices are now the largest contributor above target inflation.”

How Could Canadian CPI Data Affect USD/CAD?

The Canadian dollar is consolidating its recovery from two-month lows of 1.3586 against the US dollar heading into Tuesday's CPI settlement. This was helped by hot inflation data from the United States American dollar gained ground last week, but rising expectations of a delayed rate cut by the US central bank (Fed) capped the dollar's gains. Markets now have a 66% chance of a June Fed rate cut, CME Group's FedWatch Tool shows.

The Canadian dollar could extend its recovery if headline and core CPI data comes in higher than expected and reinforces the BoC's “higher interest rates for longer” narrative. In that case, USD/CAD could revisit the 1.3400 area. Conversely, soft Canadian inflation data could soon return BoC the rate lowers the stakes on the table and allows USD/CAD to resume its uptrend towards 1.3600.

FXStreet Principal Analyst Dhwani Mehta offers key technical levels for USD/CAD trading in the Canadian Inflation Report: “USD/CAD continues to defend the horizontal 21-day simple moving average (SMA) at 1.3470 as the 14-day Relative Strength Index (RSI Indicator) is above the midline.

“If the 21-day SMA at 1.3470 holds firm, USD/CAD could rebound to challenge the 100-day SMA at 1.3550 on the way to the two-month high of 1.3586. Next, the 1.3600 level will be on buyers' radars. On the downside, a daily close below the 21-day SMA will reopen the floors for a test of the 50-day SMA at 1.3410. Another relevant downside is the February low of 1.3365,” adds Dhwani.