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Just when we were getting ready for the weekend last Friday, Canada’s CPI surprised markets by printing a 0.6% decline in December, which dragged the year-over-year rate to 2.3% from 2.9% in November.

Core inflation figures also greatly missed expectations, clocking in a 0.5% decline from a 0.1% growth in November. What the heck happened?

As it turned out, slower-than-expected increases in gasoline and food prices, as well as lower prices for passenger vehicles, drove the readings down. Food prices reached an 18-month high with a 4.8% growth in November, but the data leveled off with a 4.4% growth in December.

Gasoline prices also dropped by as much as 3.0%, showing only a 7.6% growth in December after printing 13.5% and 18.2% increases in November and October, respectively.

And get this – analysts expect that the drop in consumer prices also had something to do with discounts during the holidays. If this is the case, then the drop in CPI might be temporary.

For now, though, it looks like the slump in CPI is pretty much seen everywhere. Canada‘s data also revealed that consumer prices rose for nine out of ten Canadian provinces, with the Prince Edward Island being the exception.

Wait a minute. Low inflation?! If you’ve been reading your School of Pipsology, you’ll know that this usually means the decreased possibility of interest rate hikes. It’s no wonder the Canadian dollar fell at the release of the report, which contributed to USD/CAD closing higher than its open price for the first time in days.

You see, prior to the release of the inflation report, the Bank of Canada (BOC) raised its inflation expectations. Central bankers estimated that inflation would average 2.2% in Q1 2012, upwardly revising it from its previous forecast of 1.9%. For the third quarter of the year, the CPI was initially predicted at 1.0% but was revised to come in higher at 1.5%.

Consequently, this had gotten a few traders excited that an interest rate hike could be in the cards soon. But the negative inflation report made some investors think twice about expecting the central bank to tighten monetary policy this year.

Now there are those who argue that we could see a rate cut in 2012 but there are also those who say that the BOC will probably just leave rates unchanged.

There’s one thing that almost everyone agrees on though. It is that we won’t hear any rate hike until 2013 as the Canadian economy copes with the effects of a possible recession in the eurozone and slower growth in China and the U.S.

USD/CAD 4-Hour Short Setup

With that said, it might be a good idea to watch out for opportunities to short the Loonie. For instance, the CAD-bearish setup that Big Pippin pointed out in the 4-hour chart of USD/CAD last week may tickle your fancy.

Remember that the interest rate is probably the biggest factor in determining the perceived value of a currency. And so, talks of a possible rate cut from the BOC may just send the Loonie even lower against the dollar.