Canadian dollar rises as oil rally eclipses inflation slowdown

By Fergal Smith

TORONTO (Reuters) - The Canadian dollar strengthened against its U.S. counterpart on Wednesday, as higher oil prices outweighed tame domestic inflation data that supported a patient approach from the Bank of Canada on raising interest rates further.

At 3:08 p.m. (2008 GMT), the Canadian dollar was trading 0.2 percent higher at 1.3148 to the greenback, or 76.06 U.S. cents. The currency, which on Monday touched its strongest in nearly three weeks at 1.3113, traded in a range of 1.3119 to 1.3176.

"This is an oil move," said Eric Viloria, an FX strategist at Crédit Agricole CIB. "It looks like the correlation between oil and the CAD has increased recently and that's really a reflection of oil becoming a more relevant driver in terms of the monetary policy outlook."

The price of oil, one of Canada's major exports, climbed after a surprising plunge in U.S. crude inventories and as OPEC's de facto leader Saudi Arabia appeared unfazed by pressure from U.S. President Donald Trump to prevent oil prices from rising. U.S. crude oil futures settled 2.6 percent higher at $56.94 a barrel.

The three-month rolling correlation between the Canadian dollar and oil has climbed to about 90 percent, according to Refinitiv Eikon data, indicating that the currency and the commodity move mostly in the same direction. In September last year, the correlation was negative.

The Bank of Canada is widely expected to leave its benchmark interest rate on hold at 1.75 percent when it decides on policy next week. In January it said low oil prices harmed the economy in the fourth quarter of 2018 and will continue to do so in the first quarter of this year.

"We are expecting the Bank of Canada to resume its normalization later this year but that's not going to happen until there's evidence that the economy is getting back on track after this oil-related slowdown," Viloria said.

Lower gasoline prices pulled Canada's annual inflation rate in January down to 1.4 percent from 2.0 percent in December, reinforcing market expectations that imminent interest rate hikes are off the table.

Canada's fourth-quarter gross domestic product data is due on Friday.

Canadian government bond prices were lower across a steeper yield curve in sympathy with U.S. Treasuries. The two-year fell 4 Canadian cents to yield 1.777 percent and the 10-year declined 41 Canadian cents to yield 1.915 percent.

(Reporting by Fergal Smith; Editing by Chizu Nomiyama)