CAD: Further to fall after tariff hit
Despite partial USMCA protection from the new 35% levy, we think markets continue to underestimate the downside risks for the Canadian economy. Expectations remain that the US and Canada will reach a deal, but progress on negotiations has been lacklustre so far and Canada’s recognition of Palestine as a state created another stumbling block.
Earlier this week, the Bank of Canada seemed to leave the door very much open to additional rate cuts if activity and/or the jobs market deteriorates. We see risks on both of these fronts, and 15bp pricing by year-end continues to appear overly conservative. We expect at least one cut by year-end in Canada, and target 1.40 in USD/CAD near-term.
CEE: PMIs expose diverging story within region
Today on the calendar, the July PMIs across the region will be of interest. In June, we saw a very mixed picture with an upside surprise in the Czech Republic and a downside surprise in Poland - another sign of the strong divergence of local stories across CEE. We generally expect some improvement in sentiment in most countries, but as June showed, the PMIs recently delivered more surprises than usual.
Yesterday, Polish inflation surprised to the upside, and the drop in headline inflation was not as pronounced as the market and we had expected, with a drop from 4.1% to 3.1%. The main source of the surprise was higher fuel and energy prices. Core inflation fell to 3.2% from 3.4% year-on-year, according to our estimates. Although the story is heading in a dovish direction, the drop has not been as fast as we expected. August inflation should also be lower, and we will see more data from the economy before the September meeting, which has mostly surprised on the dovish side in recent months. The window for a 50bp rate cut is likely closing, but the data should still allow for 25bp in September, in our view. The slower decline in inflation complicates our bearish view on Poland's zloty, but despite some hawkish repricing yesterday, the rate differential justifies levels in the 4.270-280 range for now.
