Head of FX Strategy
Inflation is no longer falling in most countries and appears to be stabilizing. In the latest reports, May inflation prints for both Australia and Canada have shown a surprising rebound.
However, with slowing growth and increasing employment pressures, some central banks are in a challenging situation.
Australia’s May inflation report showed a further increase in price pressures, marking the third consecutive month that the figure exceeded expectations. Headline May CPI reached the 4.0%-mark on the headline from 3.6% in April and 3.8% expected.
The last good news on inflation that we got from Australia was at the start of the year, when December inflation was reported to ease to 3.4% YoY, the lowest since November 2021. In the following five months, there has been either no progress on disinflation, or inflation has actually kicked higher.
The trimmed mean core measure, which smooths out volatile items, advanced to 4.4% YoY versus 4.1% a month earlier.
This has boosted the case for a rate hike from the Reserve Bank of Australia. Markets are now pricing in a 50% chance of a September rate hike, up from 15% just a day ago.
The real test for the RBA comes in July with the quarterly inflation print is released. The RBA focuses more on quarterly inflation to guide their policy as the monthly inflation prints lack details. The Q2 CPI print will be released on July 31, ahead of the RBA’s August 6 meeting.
This suggests there may be room for AUD outperformance to last, for now, as the RBA bets can remain tilting hawkish relative to other central banks for longer.
Canada’s May inflation also reaccelerated with headline CPI up 0.6% MoM vs. 0.3% expected. Annual price growth also rose to 2.9% YoY from 2.7% in April.
This report is likely a disappointment for the Bank of Canada that delivered its first rate cut in June, and raises concerns on the potential timeline of the next rate cut.
However, one data point is never a trend. However, caution is likely to set in given that disinflation progress has stalled broadly across the G10 economies. That could move the BOC to the sidelines at the July 24 meeting, especially if another upside surprise is seen in June CPI which is released on July 16.
But even a pause from BOC is not all good news for CAD, given that it comes with rising risks of a recession. Several measures of demand are slowing, and the housing market's sizeable imbalances make it particularly vulnerable to the lagged impact of higher rates. Canada’s labor market has also loosened dramatically, with the unemployment rate at 6.2% currently from the low of 4.8% in July 2022.
This means the risk/reward on the Loonie, or the CAD, remains tilted bearish. Among central bank divergence plays, USDCAD, AUDCAD and CADNOK remain well positioned.
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