TORONTO (Reuters) - Canada's dollar is expected to dip in the short term but stabilize in 12 months, a Reuters poll showed on Thursday, as a strengthening domestic economy encourages the Bank of Canada to prepare the market for interest rate hikes.
The loonie, which has been the weakest performer among G10 currencies this year, is expected to decline slightly in three months to C$1.36 to the U.S. dollar, or 73.53 U.S. cents, according to the median forecast in a survey of more than 50 foreign exchange strategists.
The currency has been buffeted this year by lower prices for oil, one of Canada's major exports, while investors have worried that the country's economy will suffer if a potential housing bubble pops or the North American Free Trade Agreement is revised.
But the poll respondents expect the currency to stabilize at C$1.36 in six months and recover to C$1.35 in a year, around where it was trading on Thursday.
Signals from the Bank of Canada that it is preparing to tighten monetary policy as the domestic economy strengthens will offset pressure from expected interest rate hikes from the U.S. Federal Reserve, strategists said.
Data on Wednesday showed Canada's gross domestic product grew at an annualized 3.7 percent pace in the first quarter following a solid expansion in the second half of 2016. The economy was also on solid footing as it ended the quarter, with growth rising by a better-than-expected 0.5 percent in March.
"There doesn't seem that much slack left (in the economy) to chew through," said CIBC Capital Markets economist Nick Exarhos. "The Bank of Canada won't be that far behind the Fed."
He expects the central bank to lift its policy rate to 1 percent from 0.5 percent in the first half of 2018.
The central bank has not raised rates since 2010, but last week it struck a more upbeat tone than investors had expected.
Canada's 2-year yield had fallen 64 basis points below its U.S. equivalent in the first half of May, its widest gap in 10 years. But the spread has since narrowed to -59 basis points.
"The Bank of Canada will prepare the ground for interest rate hikes in Canada," said Desjardins senior economist Hendrix Vachon. "That's why we believe by the end of the year we may see the Canadian dollar appreciating again."
Still, bearish bets on the Canadian dollar have reached a new high, recent data from the Commodity Futures Trading Commission and Reuters calculations show.
In May, the Trump administration set the clock ticking toward a mid-August start to renegotiate NAFTA with Canada and Mexico to try to win better terms for U.S. workers and manufacturers.
Also, progress on overhauling U.S. tax laws could give a boost to the greenback, said RBC Capital Markets Chief Technical Strategist George Davis.
He expects the loonie to weaken to C$1.40 by year-end but recover to C$1.36 in 12 months as rebounding oil prices support increased business investment and as the Bank of Canada begins to raise rates.
Polling by Sujith Pai and Krishna Eluri; Editing by Lisa Von Ahn