Euro Gains vs Loonie as Oil Drops on US Inventory Rise

Key Moments

Euro Outperforms Canadian Dollar Ahead of Eurozone Data

EUR/CAD continued to climb for a second consecutive session, trading near 1.6090 during European hours on Wednesday. Market participants are positioning ahead of the upcoming release of seasonally adjusted Eurozone Industrial Production figures for July, which are due later in the day.

The move in the cross has been driven in part by weakness in the commodity-linked Canadian Dollar (CAD), which has struggled to hold recent gains as support from rising oil prices has faded.

Markets Reprice ECB Path Beyond a Single Hike

Analysts at Rabobank report that investors are increasingly convinced that the European Central Bank is likely to deliver a broader tightening cycle rather than a single rate move. They note that “markets expect much more than a one-and-done hike.”

Rabobank’s strategists add that this repricing aligns with “expectations embedded in curves where central banks have shown a more proactive response.” They point out that, as of yesterday, “EUR money markets priced more than four additional rate hikes on top of the two the ECB has already delivered,” highlighting the extent to which rate expectations have moved ahead of the current policy stance.

Oil Pullback Weighs on CAD After Large U.S. Inventory Build

The Canadian Dollar has come under pressure as crude oil prices retreat from recent multi-month highs. The latest U.S. inventory statistics showed an unexpected increase of 7.14 million barrels for the week ending September 11, reversing a prior draw of 300,000 barrels logged the previous week.

This abrupt shift in inventory dynamics has interrupted the earlier rally in crude, limiting support for the CAD and contributing to the upside in EUR/CAD.

Middle East Disruptions Threaten to Tighten Oil Supply

Despite the latest inventory-driven setback, crude prices may soon find support as supply risks in the Middle East intensify. Energy markets are confronting renewed concerns about tightness following reports that Saudi Arabia has canceled multiple September crude shipments to European buyers.

The cancellations have emerged in the wake of drone attacks that triggered an emergency shutdown of Saudi Arabia’s key East-West pipeline. The situation has injected fresh uncertainty into supply routes and heightened the risk of further volatility in crude benchmarks.

Additional tension has arisen from renewed strikes by Iran-backed Houthi militants in the region, leaving the operational outlook for the East-West pipeline unclear. With no confirmed schedule for restoring full operations, the market remains vulnerable, particularly given the pipeline’s role as an important alternative route that enables oil flows to bypass the exposed Strait of Hormuz.

Canadian Inflation Steady as RBC Sees Limited Policy Impetus

Royal Bank of Canada economists emphasize that “Canadian inflation held at 3% year-over-year in August, unchanged from July,” characterizing the outcome as indicative of a still-elevated yet stable inflation backdrop.

They underline that headline price pressures remain restrained even though food and energy costs are still relatively high. In their assessment, these dynamics support the view that the underlying inflation trend remains broadly aligned with the Bank of Canada’s 2% objective over the medium term, suggesting limited immediate pressure for further policy tightening.

Canadian Dollar: Core Drivers and Market Sensitivities

The article also outlines several structural and cyclical forces that shape the behavior of the Canadian Dollar.

Key Forces Influencing the Canadian Dollar (CAD)

• Monetary policy: The level of interest rates set by the Bank of Canada (BoC) is a central driver for CAD. Higher relative policy rates tend to favor the currency.
• Oil prices: As petroleum represents Canada’s largest export, shifts in crude prices often have a direct and immediate impact on CAD demand.
• Domestic economic health: Indicators such as growth, inflation, and trade performance – especially the balance between exports and imports – are important for currency valuation.
• Risk sentiment: In risk-on environments, when investors are more willing to hold higher-risk assets, CAD typically benefits. In risk-off phases, demand for safer assets can weigh on the currency.
• U.S. economic conditions: Given the close trade relationship, the performance of the U.S. economy is a critical factor for CAD.

Bank of Canada Policy Transmission to FX

The Bank of Canada exerts strong influence on CAD primarily through its control of short-term interest rates that underpin borrowing costs across the economy. Its mandate is to keep inflation within a 1-3% range, adjusting rates higher or lower to achieve that objective.

Relatively higher Canadian interest rates are generally positive for the currency, while lower rates can be negative. The BoC can also deploy quantitative easing or quantitative tightening to guide financial conditions, with easing typically weighing on CAD and tightening usually providing support.

Oil and Inflation: Direct Links to CAD

Movements in oil prices are especially impactful because they affect export revenues and the trade balance. Rising crude prices often coincide with stronger CAD, while falling prices tend to be a headwind.

On the inflation front, the article notes that, in the current environment of liberalized capital flows, higher inflation can at times be associated with currency strength when it prompts central banks to raise interest rates, drawing in foreign capital seeking higher yields. In Canada’s case, such dynamics can bolster CAD when investors anticipate or react to BoC tightening measures.

Macro Data and the Broader CAD Outlook

Macroeconomic data releases serve as barometers of the Canadian economy and can shift expectations for BoC policy, thereby influencing CAD. Data points such as GDP, Manufacturing and Services PMIs, labor market statistics, and consumer sentiment surveys can either reinforce or challenge prevailing market views.

Stronger-than-expected readings tend to attract capital inflows and may encourage expectations of higher interest rates, which are supportive of the currency. Conversely, weaker data can pressure CAD by raising concerns about growth and reducing the perceived likelihood of further policy tightening.