Canada's economy is showing good signs.

Recently, there have been several significant events that have affected the Canadian economy. For example, the collapse of a bank has caused concern but overall the Canadian economy has shown signs of improvement compared to the previous year. One clear indicator is the Consumer Price Index (CPI) which has shown a significant decrease year over year. The highest point was 8.1% in July of last year but in March of this year, it was only 5.2%. Even on a month-to-month basis, the increase was only 0.4%.

In addition to the CPI, the Core Retail Sales and Retail Sales Indexes for the past month have also performed better than expected. The Core Retail Sales Index was 0.9%, and the Retail Sales Index was 1.4% which is twice as much as expected. These indicators suggest that the Canadian economy is slowly recovering.

Looking at the Bank of Canada's monetary policy the interest rate policy has been maintained at 4.5% since February making it the first major central bank to pause interest rate hikes.

The Bank of Canada (BoC) keeping interest rates low, including lower-than-expected inflation rates in Canada, has caused the USD/CAD currency pair to strengthen, reaching a new high of 1.3863 in March 2023 the highest level in four months.

Jay Zhao-Murray, a market analyst at Monex, has previously stated that "Canada's economy is vulnerable to interest rates due to factors such as our excessively high debt-to-income ratio caused by an overheated housing market." This may be one of the factors that led to the faster-than-expected decline of Canada's inflation rate.

In terms of the market, it is expected that the BoC's policy rate will peak at around 4.75% this year. Compared to the Federal Reserve's policy rate the BoC's policy rate is expected to be lower by just 50 basis points or 0.5%.

However, the BoC may not want to allow the difference in interest rate policies to be too great compared to the United States. As stated by Governor Tiff Macklem in October of last year, the bank may need to become more aggressive to respond to the weakened currency following its two-year low of 1.3977.

Royce Mendes, Head of Macro Strategy at Desjardins, has stated that "if the Canadian dollar becomes too weak it could lead to inflation in the country again."