Canadian Dollar: Inflation Risks vs. Bank of Canada Stance – TD Securities

TD Securities economist Robert Both forecasts that Canada's September headline CPI will rise to 3.2% year-over-year, driven primarily by higher energy and gasoline prices. However, core inflation measures such as CPI-trim and CPI-median are expected to remain at moderate levels near 1.9%. This divergence suggests that while headline inflation data may temporarily firm, underlying price pressures have not significantly heated up.

**Energy Prices Lift Headline Reading, Core Metrics Stay Restrained**

Both noted that the periodic rebound in energy and gasoline prices is the main driver behind September's higher headline inflation. However, core indicators, which exclude volatile items, continue to hover near the lower bound of the 2% target range, reflecting no signs of overheating in Canada's domestic demand side. According to TD Securities analysis, while the Bank of Canada may revise up its short-term forecast for headline CPI in the October Monetary Policy Report (MPR), weak core inflation performance will serve as a key basis for holding rates steady.

**Economic Weakness and Trade Risks Weigh on Canadian Dollar**

Market signals indicate that Canada's domestic economic momentum is soft, compounded by US-Canada trade tensions, which continue to drag on the commodity-linked Canadian dollar. USD/CAD previously touched 1.4292, a high since April 2025, and while it has since pulled back slightly, it remains near the 1.42 level. CIBC Capital Markets expects the Bank of Canada will not follow market pricing for rate hikes this year, and with the widening US-Canada rate differential, USD/CAD could average 1.42 in Q4 2026. The bank also forecasts that if trade negotiations make progress, the exchange rate could ease back toward 1.37 by mid-2027.

**Technical Overbought Signals, Short-Term Pullback Risk in Focus**

Some technical analysis suggests that after a sustained rally in USD/CAD, both RSI and stochastic indicators have rolled over from elevated levels, with the pair initially breaking below its short-term uptrend line. A further loss of the 1.42 level could trigger a more pronounced correction, with downside support seen at 1.40 and 1.39 respectively; upside resistance lies at 1.43 and 1.4350. Market focus now shifts to the upcoming Canadian September employment data to further assess economic fundamentals and the central bank's policy path.