Euro Advances Against Canadian Dollar as Markets Eye ECB Pause and Oil Risk

Key Moments

Euro Strengthens as ECB Seen Nearing End of Rate-Cut Cycle

EUR/CAD continued to move higher for a second consecutive session, trading near 1.6210 during European hours on Monday. The cross advanced as the Euro (EUR) drew support from growing expectations that the European Central Bank (ECB) is approaching the end of its rate-cutting phase.

Eurozone headline inflation eased to 2.0% in December, marking a four-month low and aligning with the ECB’s target. Core inflation declined to 2.3%, coming in slightly below expectations. The moderation in inflation reinforced the view among policymakers that the ECB is likely to keep interest rates at current levels unless there is a substantial shift in the economic outlook.

Geopolitical Tensions in the Arctic Add to Market Caution

Market participants also turned more cautious as European countries, led by the United Kingdom (UK) and Germany, engaged in discussions about enhancing their military presence in Greenland to bolster security in the Arctic region.

Germany may put forward a proposal for a joint NATO mission, while UK Prime Minister Keir Starmer has called on allies to increase efforts in the High North. These developments come amid renewed remarks by US President Donald Trump advocating US ownership of Greenland.

Oil-Linked CAD Finds Support as Supply Risks Rise

Further gains in EUR/CAD could be constrained by support for the Canadian Dollar (CAD), which is closely tied to commodity prices. The CAD drew backing from rising Oil prices, as WTI climbed on heightened concerns over supply disruptions linked to escalating protests in Iran.

Iran exports nearly 2 million barrels per day (bpd) and is the fourth-largest producer within OPEC, meaning any significant escalation presents a notable risk to global Oil supply.

Canadian Labor Market Data Shows Uneven Progress

On the domestic front, Canadian labor market figures pointed to a slower pace of job creation. Employment in Canada increased by only 8,000 in December, following a strong cumulative gain of 181,000 over the preceding three months.

The unemployment rate rose to 6.8% from 6.5%. This uptick was attributed primarily to a larger proportion of people entering the labor force rather than an increase in layoffs.

Royal Bank of Canada (RBC) Senior Economist Claire Fan said the data do not signal a setback, noting that the modest job gain and higher unemployment support the view that Canada’s labor market recovery is underway but likely to remain uneven, with slack absorbed gradually over time.

Snapshot: Key Eurozone and Canadian Indicators Mentioned

Canadian Dollar: Core Market Drivers Explained

The Canadian Dollar (CAD) is influenced by several key market forces that interact to shape its performance. These include interest rate policy, commodity prices, domestic economic conditions, inflation, external trade, and overall risk sentiment in global markets.

Interest Rates and Bank of Canada Policy

The level of interest rates set by the Bank of Canada (BoC) plays a central role in determining the value of the CAD. The BoC sets the benchmark rate at which banks lend to each other, which then affects borrowing costs across the economy.

The BoC’s primary objective is to keep inflation within a 1-3% range by raising or lowering interest rates as needed. In general, comparatively higher interest rates are supportive of the Canadian Dollar. The central bank can also deploy quantitative easing or quantitative tightening to adjust credit conditions, with quantitative easing typically seen as CAD-negative and quantitative tightening as CAD-positive.

Oil Prices and Trade Balance Effects

Oil prices are a crucial factor for the Canadian Dollar, as petroleum is Canada’s largest export. Movements in Oil prices tend to have a direct and often immediate impact on CAD.

When Oil prices rise, demand for the Canadian Dollar usually strengthens, both because of higher export revenues and the increased likelihood of a favorable Trade Balance, which occurs when exports exceed imports. Conversely, falling Oil prices generally weigh on the currency.

Inflation Dynamics and Capital Flows

Although inflation has traditionally been viewed as negative for a currency because it erodes purchasing power, the modern environment of relatively open capital flows has changed this relationship.

Higher inflation can prompt central banks, including the BoC, to raise interest rates. Such rate hikes can attract foreign capital seeking higher returns, thereby increasing demand for the Canadian Dollar. As a result, in current market structures, higher inflation can sometimes coincide with currency strength if it leads to tighter monetary policy.

Macroeconomic Data and Overall Economic Health

Broader macroeconomic indicators also shape market expectations for the CAD. Data releases covering Gross Domestic Product (GDP), Manufacturing and Services Purchasing Managers’ Indexes (PMIs), employment figures, and consumer sentiment all contribute to the assessment of Canada’s economic health.

A strong set of data tends to support the Canadian Dollar by encouraging foreign investment and potentially prompting the BoC to consider higher interest rates. Weak data typically has the opposite effect and can pressure the currency lower.

Risk Sentiment and External Linkages

Market sentiment – whether investors are favoring risky assets (risk-on) or seeking safety (risk-off) – is another important driver. In risk-on environments, the CAD generally benefits, while risk-off episodes can dampen demand.

Additionally, given the close economic relationship with the United States, the condition of the US economy is a major external factor influencing the Canadian Dollar. Changes in US growth, demand, and policy can all transmit to CAD performance through trade and financial channels.