TORONTO (Reuters) - The Canadian dollar strengthened against the U.S. dollar on Tuesday after the Bank of Canada kept interest rates on hold, but reiterated its view that it will need to tighten policy over time.
The central bank held its overnight lending rate steady at 1 percent, as expected - the longest period of BoC inactivity since the early 1950s. Investors were focused on the bank’s language for any indication that its intent to tighten monetary policy had shifted.
Bank of Canada Governor Mark Carney, who recently said he will take the reins at the Bank of England next July, has been signaling a need to raise the main policy rate since April, making Canada the only industrialized economy to lean toward a rate increase.
Overnight index swaps, which trade based on expectations for the central bank’s key policy rate, showed that after the announcement traders scaled back their small bets on a rate cut in 2013.
“The Canadian dollar has had a certain amount of volatility today ... most of it on the Bank of Canada guidance,” said Jack Spitz, managing director of foreign exchange at National Bank Financial.
The Canadian dollar finished Tuesday’s session at C$0.9932 against the U.S. dollar, or $1.0068, compared with C$0.9949, or $1.0051, at Monday’s North American close.
Camilla Sutton, chief currency strategist at Scotiabank noted the Canadian dollar has held back while other currencies rallied, but could now strengthen over the next few weeks to C$0.9750, or $1.0256.
“The Canadian dollar wasn’t (rallying) as it was waiting for the Bank of Canada risk to pass. Now that it’s passed, this type of steady-as-she-goes statement opens up the potential for Canadian dollar strength,” Sutton said.
Canada’s dollar finished the day outperforming most major currencies, including the euro.
The currency firmed briefly to a session high of C$0.9915, or $1.0086 after U.S. President Barack Obama said in a television interview the Republicans’ proposed fiscal cliff plan was still “out of balance.”
Obama rejected the proposal for the fiscal crisis and said any deal must include a rise in income tax rates on the wealthiest Americans.
Analysts warn that another recession will hit if U.S. lawmakers do not come to an agreement over how to deal with C$600 billion in tax hikes and spending cuts that are set to kick in early next year.
“It may take the 11th hour and 59th minute, but I do believe a (U.S. fiscal) deal can be done. Now whether that deal holds really remains to be seen,” said Spitz.
The Canadian dollar has been trading within a narrow band between C$0.9962 and C$0.9906 for the last week and a half and only a resolution of the U.S. “fiscal cliff” or a decision by Canada over key takeover deals will push the currency through recent levels, he added.
A C$15.1 billion takeover of Nexen Inc NXY.TO by China’s state-owned CNOOC Ltd (0883.HK) is on hold while the Canadian government reviews the deal. Progress Energy Resources Corp (PRQ.TO), a mid-size Canadian gas producer, and Malaysia’s Petronas (PETR.KL) are also waiting for Ottawa to greenlight their C$5.2 billion ($5.2 billion) takeover.
Canadian bond prices rose across the curve. The two-year bond rose half a Canadian cent to yield 1.059 percent, and the benchmark 10-year bond was up 1 Canadian cent to yield 1.698 percent.
Additional reporting by Alastair Sharp, editing by Gary Crosse