Canada’s credibility in global markets has long depended on its commitment to keeping inflation low and predictable. For months now, economists, traders, and policymakers have been closely watching the inflation data. The latest figures show that underlying price pressures are continuing to ease, and the expectations for monetary policy are changing, creating more demand for the Canadian dollar.
Behind the Numbers
Canada’s Consumer Price Index rose 2.3% year over year in January, landing slightly below what many analysts had projected. The primary driver was a sharp decline in gasoline prices, which plunged roughly 16.7% year over year. At the same time, key measures of core inflation also moved lower.
What matters most to markets and to the Bank of Canada isn’t just the CPI number but what drives it. Core inflation eased to its lowest readings in years. The trimmed mean core rate is at its weakest point since 2021, and the median core gauge settled near 2.5%.
Core inflation is the most important measure of persistent price pressures for central bankers. When it begins trending toward the Bank of Canada’s 2% midpoint target, policymakers consider whether further tightening is necessary to fight inflation.
Subtle Strength Amid Changing Expectations
For the Canadian dollar (CAD), these developments matter because foreign exchange market prices currencies by expectations for interest rates and economic growth alongside long-term fundamentals. When inflation cools, investors start to reassess how likely it is that the Bank of Canada will raise, hold, or cut interest rates.
After the latest inflation report, the Canadian dollar initially weakened against the U.S. dollar as markets priced in a greater probability of rate cuts rather than hikes. On February 17, the CAD fell to an 11-day low against its U.S. counterpart, with USD/CAD trading at 1.3655. Traders interpreted the easing inflation data as a signal that rate cuts may be on the horizon, especially if broader economic indicators such as employment or consumer spending show signs of slowing. Interest rate differentials are a key driver of demand in the currency markets, and even modest adjustments in policy expectations can move exchange rates within minutes of a data release.
For retail traders monitoring price action on a forex trading app in real time, those moments can create short-term opportunities as markets quickly adjust to new policy signals.
Trade and Growth Still in Play
Inflation isn’t the only factor influencing the CAD. A narrowing trade deficit and diversification away from the United States have also shaped currency dynamics. Canada’s trade balance narrowed more than expected in December 2025,, even as shipments to the U.S. shrank to historically low levels.
Canada is navigating substantive changes in global demand patterns. Diversifying trade partners and exporting higher-value goods can help reduce dependency on any single market. For the Canadian dollar, that’s a subtle but meaningful fundamental tailwind.
However, these adjustments are not without risk. Geopolitical tensions and potential renegotiations of trade agreements like the United States-Mexico-Canada Agreement (USMCA) are priced in as risks alongside inflation trends.
The Bank of Canada’s Dilemma
Cooling inflation gives the Bank of Canada the freedom to avoid raising rates further and to keep borrowing costs steady. On the other hand, cutting rates too soon can undermine confidence in price stability, especially if underlying risks suddenly flare.
Governor Tiff Macklem has stressed that the BoC will watch how temporary factors and structural changes unfold before making major policy shifts. With core inflation trending lower but still coupled with food price pressures and geopolitical uncertainty, the bar for rate cuts remains high.
Bank of Canada Governor Tiff Macklem has stressed that policymakers are navigating a period of structural adjustment and uncertainty, and that monetary policy will not react to short-term volatility. He has explained that the Bank must carefully distinguish temporary factors from persistent trends before making major policy shifts.
This cautious narrative resonates in markets. Traders are now pricing in only a moderate chance of interest rate easing later in 2026, a sharp move from earlier bets on aggressive loosening.
What Comes Next for the Canadian Dollar
Data will lead the direction of the Canadian Dollar. Wage growth indicators, consumer spending reports, trade figures, and upcoming CPI readings will all affect market expectations.
Another layer of complexity comes from the U.S. monetary policy, global growth trends, and commodity price fluctuations. These all have power on the Canadian dollar. For example, when U.S. inflation comes softer than expected, as it has recently, this can boost the CAD by reducing the relative attractiveness of the U.S. dollar.
Forecasts suggest core inflation will remain in the mid-2% range through much of 2026, a setup that allows the Bank of Canada to maintain a steady course without threatening price stability.
See Also:
How Strong Will the Canadian Dollar be in 2026? | Disruption Banking
