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Canada’s Softer Inflation Drags Down Yields, Adds Pain to Loonie

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(Bloomberg) — The Canadian dollar extended its descent to new lows as softer-than-expected inflation dragged down local yields, further diminishing the currency’s appeal. 

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The US dollar-loonie pair rose as much as 0.8% to 1.3354, the weakest since November 2020, as inflation slowed to 7% in August, compared to a 7.3% median forecast from economists surveyed by Bloomberg. That’s led investors to bet the nation’s central bank may not need to keep raising rates as aggressively, just as markets brace for another jumbo hike from the Federal Reserve.

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The Canadian dollar is on a weakening trend since mid-August, as surging US Treasury yields make the greenback a more attractive option. The US Treasury yield spread over its two-year Canadian counterpart widened to 23 basis points on Tuesday, the highest since August 2019. 

The increase in rate differentials will contribute to a move lower for the loonie, said Bipan Rai, head of foreign-exchange strategy at Canadian Imperial Bank of Commerce. He expects the Canadian currency to weaken to 1.35 per US dollar over the near term and sees the nation’s rates peaking at a lower level than in the US.

The Canadian dollar is down 2.7% against the greenback over the past month, extending its year-to-date loss to 5.4%. It’s still outperforming most of its Group-of-10 counterparts, only behind the Swiss Franc this year. The country’s economy has been helped by higher prices for commodities and energy and a scaling back of Covid restrictions, with growth actually accelerating in the second quarter even as global recessionary concerns mounted. 

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