Time of release: 06/29/2011 11:00 GMT, 7:00 EST

Consumer prices in Canada are expected to grow at an annualized pace of 3.3% for the third consecutive month in May, and slowing inflation could weigh on the exchange rate as the central bank maintains a balanced tone for future policy. Although the Bank of Canada shows an increased willingness to normalize monetary policy, easing price pressures will certainly allow the central bank to keep borrowing costs on hold throughout the second-half of 2011, and the recent weakness in the Canadian dollar may gather pace heading into July as interest rate expectations falter. In turn, the USD/CAD may continue to retrace the sharp decline from earlier this year, and the exchange rate looks poised to push higher in the coming months as it maintains the upward trend from the May low (0.9445).

As raw materials prices gather pace, firms may pass on higher costs onto consumers, and a rise in the CPI could encourage the BoC to lift the benchmark interest rate from 1.00% as the central bank aims to balance the risks for the region. However, the slowdown in private sector consumption paired with the deterioration in global trade may lead businesses to absorb higher costs, and a softer-than-expected inflation report could weigh on interest rate expectations as Governor Mark Carney maintains his pledge to carefully consider future rate hikes. In turn, the central bank head may continue to endorse the wait-and-see approach over the coming months, and the loonie certainly remains at risk of facing additional headwinds over the near-term should growth and inflation slow in the second-half of the year.

Trading the given event risk may not be as clear cut as some of our previous trades as the headline reading for inflation is expected to hold steady for the third consecutive month in May, but an uptick in the CPI could pave the way for a long Canadian dollar trade as investors continue to see a rate hike in 2011. Therefore, if price growth increases at an annualized pace of 3.4% or higher, we will need to see a red, five-minute candle following the release to generate a sell entry on two-lots of USD/CAD. Once these conditions are fulfilled, we will place the initial stop at the nearby swing high or a reasonable distance after taking market volatility into account, and this risk will establish our first target. The second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its mark in an effort to lock-in our winning.

On the other hand, businesses may keep a lid on prices in order to stimulate domestic demands, and a weaker-than-expected CPI report could generate additional Canadian dollar weakness as rate expectations deteriorate. In turn, if the headline reading for inflation holds steady at 3.3% or unexpectedly weakness from the previous month, we will implement the same strategy for a long dollar-loonie trade as the short position laid out above, just in reverse.