The Canadian dollar will strengthen over the coming year as higher oil prices provide support, but monetary policy divergence and US election risk will restrain the currency in the near term, a Reuters poll found.
The loonie is forecast to be little changed at C$1.3200 in three months, the poll of over 40 foreign exchange strategists showed, down just 0.2 percent from Wednesday's close of C$1.3175. The forecast is a downgrade from C$1.3100 forecast a month ago.
"We see monetary policy still being an important driver of the weakness in the Canadian dollar through the end of the year," said Ian Gordon, FX strategist at Bank of America Merrill Lynch.
Gordon expects the US Federal Reserve to raise interest rates in December and twice more in 2017, even as the Bank of Canada is largely forecast to keep rates unchanged until at least the end of next year.
"We think the market is underpricing the risk that the Bank of Canada takes a dovish turn, given the weakness in non-energy exports and the recent decline in inflation," Gordon added.
Canada's closely watched core inflation rate fell in August to 1.8 percent, its lowest in two years, reviving talk the BOC was more inclined to ease monetary policy than tighten.
Overnight index swaps showed the chances of an interest rate cut by mid-2017 stand at about one-in-four.
Canada's economy is less sensitive than previously to shifts in the currency, such that the weakening of the Canadian dollar over the last few years may not yet be enough to help rebalance the economy, said Elsa Lignos, a currency strategist at RBC Capital Markets.
Still, strategists expect the loonie to strengthen to C$1.3000 in a year, matching the level estimated a month ago.
Pressure on the Canadian dollar from Fed rate hikes will be offset by higher oil prices, said Jimmy Jean, senior economist at Desjardins.
He forecast the local currency to gradually climb in the second and third quarters of 2017 as a Bank of Canada rate hike cycle moves into focus.
But the 12-month forecast in the latest poll, ranging from a gain of 24 percent to a fall of 6 percent, suggested that uncertainty remained high.
Canada's government is facing increased pressure to support the economy through more fiscal stimulus as infrastructure spending takes time to kick in and record high debt loads dampen the impact of stimulus checks.
Further fiscal stimulus might kill the market's bias for a Bank of Canada rate cut and support the currency, Jean said.