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The Canadian dollar CADUSD weakened to a three-month low against its U.S. counterpart on Tuesday as cooler-than-expected domestic inflation data bolstered expectations of the Bank of Canada beginning to cut interest rates in the coming months.

The loonie was trading 0.5% lower at 1.36 to the U.S. dollar, or 73.53 U.S. cents, after touching its weakest intraday level since Dec. 12 at 1.3609.

Canada’s annual inflation rate in February unexpectedly cooled to 2.8%, its slowest pace since June, and core inflation measures eased to more-than two-year lows.

“The Canadian economy is much weaker than the headline data suggests, and we’re now starting to see that weakness manifest within nearly all macro indicators, even the BoC’s preferred core measures of inflation that were a major sticking point for the bank back in 2023,” said Simon Harvey, head of FX analysis for Monex Europe and Monex Canada.

Money markets see a 75% chance of the BoC easing in June, up from roughly 50% before the data.

“The Bank of Canada is in a tough place,” said Darcy Briggs, a portfolio manager at Franklin Templeton Canada.

“The data alone ... it would suggest that the Bank of Canada has a green light to cut rates but they’re kind of tethered to Fed policy. And part of that has to do with if they start cutting too soon or by a greater amount then you could have the loonie depreciate quite dramatically.”

Investors are concerned that the Federal Reserve will reveal new economic projections on Wednesday that signal fewer interest rate cuts and a later start to the policy easing cycle.

Canadian government bond yields fell across the curve. The 2-year dropped 14.8 basis points to 4.151%, while the 10-year was down 10.1 basis points at 3.496%.

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