Special topic: ATFX forex column submission on September 18. In response to potential high inflation driven by elevated oil prices, the Bank of Japan has raised interest rates six times, the European Central Bank has hiked twice, the Federal Reserve has increased rates once, and the Bank of England has also lifted rates on one occasion. Yet, the Bank of Canada has remained notably inactive throughout this cycle.
Interest rates serve as the fundamental driver behind currency valuations. The BoC's persistent reluctance to tighten monetary policy significantly heightens the risk of substantial depreciation for the Canadian dollar relative to its US counterpart. Since September 9, 2026, the USD/CAD pair has recorded eight consecutive bullish daily candles, with the market price climbing from a low of 1.3765 to yesterday's high of 1.4000, marking a fresh multi-week peak.
As a commodity currency, the Canadian dollar typically benefits from elevated international crude oil prices, which strengthen fiscal revenue expectations and consequently support the currency's value. Currently, WTI crude is trading near $95 per barrel, while Brent crude stands at approximately $102 per barrel, both occupying historically high price ranges. From a commodity currency perspective, the loonie should theoretically be appreciating rather than depreciating against the greenback. However, when factoring in the lag effect of interest rate decisions, the Canadian dollar's weakness relative to the US dollar appears entirely justified.
Figure 1: Canada Government Bond Yield Summary - ATFX
As illustrated in the accompanying chart, the one-month Canadian government bond yield currently stands at 2.28%, merely three basis points above the Bank of Canada's current overnight rate of 2.25%. This narrow spread signals that the central bank has no imminent plans for a rate adjustment within the coming month. Meanwhile, the one-year government bond yield sits at 2.98%, roughly 73 basis points higher than the prevailing overnight rate, implying that the market anticipates at least three rate hikes over the next twelve months. However, mere expectations of future tightening are insufficient; the critical factor remains narrowing the timeline to the initial rate increase.
Figure 2: Canada Headline CPI and Core CPI Year-over-Year Comparison - ATFX
According to data from Statistics Canada, the country's August headline CPI registered an annual rate of 3%, while core CPI came in at 2.4%, both exceeding the 2% inflation target. Since the beginning of 2024, Canada's inflation rate has maintained a largely horizontal trajectory, which was previously interpreted as a positive indication of price stability. Nevertheless, ever since Federal Reserve Chair Kevin Warsh characterized persistently above-target inflation as failing to meet objectives, central banks worldwide have rapidly adopted similar reasoning. The Bank of Canada is no exception; with an explicit 2% inflation mandate, any CPI reading exceeding that threshold represents a failure to achieve its policy goal.
From an inflation standpoint, the BoC should logically follow the Federal Reserve's lead in raising rates. However, when considering trade dynamics, the central bank finds itself constrained to maintaining its current stance. The United States has imposed a 5% tariff on Canadian steel, automobiles, and other industrial sectors, delivering a substantial blow to Canada's macroeconomic outlook, which relies heavily on exports to its southern neighbor. Canadian Prime Minister Carney is actively pursuing various measures to bolster domestic economic resilience and reduce dependence on the US market, aiming to mitigate the adverse effects of these tariff policies on Canada's broader economy. A key component of this strategy involves preserving accommodative monetary conditions, which dramatically reduces the likelihood of the BoC implementing rate increases under current circumstances.
Weighing elevated inflation against the BoC's constrained position due to trade frictions, the most probable outcome remains continued depreciation pressure on the Canadian dollar relative to its US counterpart. The primary risk factor lies in the possibility of a sharp decline in international oil prices, which would diminish inflationary expectations and potentially prompt the Federal Reserve to pause its hiking cycle or even pivot toward easing. Such a scenario could trigger US dollar weakness and, conversely, drive appreciation in the Canadian dollar.
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