The recent upsurge in Canada's dollar will fade in coming months on prospects the Bank of Canada sounds less hawkish on interest rate hikes and fails to keep pace with the US Federal Reserve, a Reuters poll found. The loonie will trade at C$1.260 in a month, compared to the C$1.2565 it was trading this month, the poll of more than 50 foreign exchange strategists showed. Further losses are expected, with forecasters predicting the currency at C$1.277 in three months and C$1.290 in a year.
The loonie had soared some 10 percent since May on the back of a softer greenback and strong economic data that spurred the BOC to increase rates last month. "It is the view that the Bank of Canada is going to outgun the Fed that is propelling the Canadian dollar," said Avery Shenfeld, chief economist at CIBC Capital Markets. "It won't last if the BOC talks a bit more dovishly in September and the US data firms up to point to a Fed hike by December."
Softening US inflation and political turmoil have hit prospects of another Fed rate hike in coming months and sent the dollar index down more than 9 percent from its January peaks. While speculators have cut their positions in favor of the dollar, they have increased bullish bets on the loonie to their highest since March, latest data from the US Commodity Futures Trading Commission showed.
A separate Reuters poll of primary dealers showed after taking rates higher for the first time in seven years in July the BOC will follow up with another increase in October, and two more next year. But strategists in the latest foreign exchange poll said the Canadian central bank is likely to play down the need for an aggressive rate hike policy next month in an attempt to curb the loonie's rally. A strong currency not only slows inflation but also hampers export growth that the central bank is counting on.
"An 8 percent appreciation of the loonie since June (if sustained) is equivalent to a 50 basis point interest rate increase, something that chops about 0.3 percent from real GDP," said Krishen Rangasamy, senior economist at National Bank of Canada. While higher prices of oil - one of Canada's key exports - have lent support to the local currency in recent months, it remains 56 percent below a pre-crisis peak of $116 a barrel. A separate Reuters poll showed analysts are bearish about the commodity due to concerns over compliance with an Opec-led deal to limit production.
Another major headwind for the loonie is the fate of the North American Free Trade Agreement, which is set to be renegotiated this month. While US President Donald Trump said earlier this year he expected only "tweaks" to America's trade relationship with Canada, his administration has since imposed anti-dumping duties on Canadian softwood lumber. Economists say the trading arrangement may be subject to more than minor tweaks which has worried Canadian policymakers and exporters given Canada sends over 75 percent of its exports south of the border.
"This is something that could weigh on the Canadian dollar especially given our negotiating position is not necessarily the strongest one. We depend on the US more than they depend on us in terms of exports," said Rangasamy. He expects the currency to weaken to C$1.30 in six months.