Synopsis:

MUFG forecasts a limited upward trajectory for the Canadian dollar (CAD) in the near term, with the USD/CAD pair expected to continue trading in the high 1.30s over the coming months. The bank cites diverging inflation paths between Canada and the U.S. as a key factor influencing this outlook.

Key Points:

• Recent Performance of CAD: The Canadian dollar showed strength last week, performing well alongside the Swiss franc. Despite this, MUFG predicts that these gains are not likely to sustain, anticipating that the USD/CAD will remain in the high 1.30 range.

• Diverging Inflation Trends: A significant driver behind the anticipated movement in USD/CAD is the divergent inflation trajectories in Canada and the U.S. While the U.S. has experienced a series of upside inflation surprises, Canada's core inflation has been surprisingly low in the early months of the year, following persistent highs in the latter half of the previous year.

• Canadian Inflation Dynamics: Canada’s core inflation, which had been stubbornly high, has begun to decrease since the start of the year. The Bank of Canada’s (BoC) preferred measures of core inflation — median and trimmed — slowed to an annual rate of 3.0% in March. This deceleration is more pronounced when looking at the last six months' data, adjusted for seasonality, which shows an annualized rate increase of only 2.5%.

• Monetary Policy Implications: The softening core inflation in Canada is likely to open the door for the BoC to start reducing interest rates, contrasting with the inflation scenario in the U.S., where the Federal Reserve faces ongoing inflation pressures.

Conclusion:

While the Canadian dollar has recently shown some strength, MUFG maintains a cautious outlook, expecting limited gains with potential downward pressure influenced by broader economic factors, particularly inflation and monetary policy divergences with the U.S.