September 3, 2014 / 2:33 PM / 3 years ago

Canadian dollar on course for a long-term grind lower

4 Min Read

Bank of Canada Governor Mark Carney holds the new Canadian 5 and 10 dollar bills, made of polymer, during an unveiling ceremony at the Bank of Canada in Ottawa April 30, 2013.Chris Wattie

TORONTO (Reuters) - A prolonged grind lower is likely in store for the Canadian dollar over the next year, with a sidelined central bank at home and an accelerating economic recovery south of the border expected to weigh on the currency, a Reuters poll found.

The loonie has had a turbulent year, marked by a sharp selloff starting in January. By early July, the currency had recovered, only to slip again through the rest of the summer.

And while the loonie managed to rally back again a bit last week, that is not expected to last. Analysts were more bearish on the loonie in the medium- and long-term.

"From here forward, we're pretty negative on the loonie," said Greg Moore, senior currency strategist at Royal Bank of Canada in Toronto. RBC sees the U.S. dollar at C$1.17 in a year, weaker than the poll's median forecast.

A stronger U.S. economic recovery and a Federal Reserve that is nearly done winding down its extraordinary stimulus measures and now focused on the timing of a first interest rate hike is seen leaving the loonie caught in the cross-hairs of broad U.S. dollar strength.

The Canadian dollar isn't likely to get any support from the Bank of Canada, which is expected to leave its benchmark interest rate unchanged until well into next year.

Concerns over low inflation and weaker-than-expected export and business investment growth are some of the reasons keeping rate hikes at bay in Canada, a Reuters poll showed last week.

Many commentators have also pointed to the risk of a severe correction in Canada's buoyant housing market when borrowing costs start to rise. Canadian households, on average, already hold debt worth over 1.5 times their income.

The poll of 46 analysts found the U.S. dollar is expected to trade at C$1.09, making one loonie worth 91.74 U.S. cents, in one month. That is unchanged from August's poll and not far from where it traded on Tuesday.

The U.S. dollar is expected to hit C$1.10 in three months, which would mean an annual loss of 3 percent for the loonie, about half the size of last year's drop.

From there, the U.S. dollar is seen at C$1.11 in six months and C$1.12 in a year from now.

Analysts say the weakness in the Canadian dollar in the months to come will be driven mainly by an increasing focus on U.S. catalysts and a stronger greenback.

"Over the past 12 months, there was a real focus on what was going on at the Bank of Canada, how the tone was shifting there," said RBC's Moore.

"Part of that lack of focus on the Fed was that there was not all that much changing there. Now there's quite a bit of potential for change at the Fed as they approach the end of quantitative easing and start talking about when they're going to start hiking rates."

Still, the Bank of Canada is not completely out of the picture. It will release its latest monetary policy statement later on Wednesday, and is expected to hold a balanced tone.

"Generally there's no change in my view in the longer term outlook: the U.S. dollar will trade higher and the Canadian dollar is very likely to weaken," said Shaun Osborne, chief currency strategist at TD Securities in Toronto.

"I think there's a lot of headwinds blowing against the Canadian dollar and against the Canadian economy."

Polling by Swati Chaturvedi in Bangalore; Editing by Chizu Nomiyama

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