The prospects of a rate hike to 4.50 percent by the Bank of Canada in July has drawn quite a bit of attention by the… … markets after the central banks core CPI measure surged to a four year high of 2.5 percent in April.

This represents a complete 180 degree turn from their policy
stance just a few months ago, when the Bank of Canada said that risks to
the economy were balanced. In fact, after the most recent policy
meeting, the Bank issued a very hawkish policy statement saying that
there is an increased risk that future inflation will persist above
the 2 percent inflation target and that some increase in the target for
the overnight rate may be required in the near term. However, the
release of May CPI figures could curtail some of the markets rate hike
expectations as the Bank of Canadas core measure is anticipated to ease
back to 2.3 percent while the headline reading is forecasted to hold
steady at 2.2 percent. Nevertheless, should the core reading hold above
the Banks 2.0 percent target, traders will continue to look forward to
policy tightening in July. On the other hand, if the markets see a
surprisingly sharp contraction in prices, bond and FX markets could be
sent reeling as the Bank of Canada would be less likely to take action
next month.

Bonds – 10-Year Canadian Government Bond Futures

While 10-year Canadian government bonds eased back slightly today,
leading yields higher, the pick up from the June 13th lows of 109.10
could continue if Tuesdays CPI report shows that inflation pressures
are easing. Prices could take aim on the 111.00 level, especially if the
data raises the potential that the Bank of Canada will leave rates on
hold in July. On the other hand, if the central banks core measure is
released stronger-than-expected, CGBs could plummet, especially as CPI
above the BOCs 2.0 percent target will up the ante for policy
tightening in the near-term.

FX – USD/CAD

Of all the Canadian financial markets, the Canadian dollar has garnered
the most attention over the past two months as the currencys steep
rally stirred fears of a move towards parity with the US dollar.
However, since hitting formidable support at 1.0550, USDCAD has quietly
worked its way up above 1.0700 from greatly oversold levels and
Tuesdays Canadian CPI report may only exacerbate this move. The Bank
of Canadas core inflation measure for May is anticipated to ease back
to 2.3 percent from four highs of 2.5 percent, signaling that prices
pressures may be abating and that Aprils surge was just a one-off
event. Such a result would lessen speculation for a hasty rate hike by
the central bank in July, especially if the figure is released at a
lower-than-expected rate, and could push USDCAD up to test 1.0750.
However, even if we do see softer inflation figures, the move higher may
be very brief as long as the core measure remains above the Bank of
Canadas 2.0 percent target, since they will still be very likely to
pursue policy tightening next month.

Equities – S&P/TSX Composite Index

Canadian stocks rose for a fourth straight day, leading the S&P/TSX
Composite Index up 0.3 percent to close at a record of to 14,176.42 in
Toronto. Reports that BHP Billiton Ltd. is considering bids for Alcan
Inc. or Alcoa Inc. reignited speculation that there will be a bidding
war involving the aluminum producers, leading shares of Alcan to gain 81
cents to C$89.50. Meanwhile, crude oil for July delivery gained 1.6
percent to $69.09/bbl in New York after Nigerian labor unions threatened
to strike this week. The news helped push EnCana, Canada's biggest
natural-gas producer 31 cents higher to C$70.52 for its second straight
record.

The S&P/TSX could be in for additional gains on Tuesday for a break of
the May high of 14,216.21, as inflation pressures are forecasted to drop
off. The Bank of Canadas core CPI measure is predicted to ease down to
2.3 percent from its four year high of 2.5 percent, which could lead
traders to believe that the central bank will hold off on raising
interest rates in July to 4.50 percent. However, as long as core
inflation holds above the Banks 2.0 percent target, a rate hike could
still be in the cards and any gains in the S&P/TSX could be limited. On
the other hand, if inflation reports are actually released at
stronger-than-expected figures, there will be little doubt that policy
tightening looms on the horizon and Canadian equities could be driven
lower, leading the S&P/TSX towards 14,000.

DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com

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