March 4, 2015 / 3:18 PM / 3 years ago

Lower interest rates, cheap oil to drive Canada dollar lower

OTTAWA (Reuters) - The beleaguered Canadian dollar will bear more pain in the coming months as diverging central bank policies between Canada and the United States will give investors few reasons to buy the loonie, according to a Reuters poll.

A Canadian dollar coin, commonly known as the "Loonie", is pictured in this illustration picture taken in Toronto January 23, 2015. REUTERS/Mark Blinch

The cheap price of oil - a major export for Canada - will also be a main catalyst as it becomes clearer what impact the drop in crude is having on the economy.

An unexpected interest rate cut from the Bank of Canada sent the Canadian dollar down over 9 percent in January, the currency’s worst month since the peak of the financial crisis in 2008.

While the loonie clawed back some gains in February, that is likely to be short-lived. The median forecast of 50 strategists has the Canadian dollar trading at C$1.25, or 80 U.S. cents, in a month from now, close to where the loonie was trading at on Wednesday.

Analysts were increasingly pessimistic on the loonie’s longer term prospects. The currency is seen weakening to C$1.28 six months from now, more bearish than the six-month outlook of C$1.27 from February’s poll.

March’s poll was taken before an interest rate announcement by the Bank of Canada, which is due later on Wednesday. While the bank is expected to hold rates at 0.75 percent, analysts anticipate one more rate cut by mid-year, which could spell another rung lower for the Canadian dollar.

“The January cut was framed as ‘insurance’ by the Bank of Canada, which suggests it was done because of the uncertain impact of lower oil prices,” said Greg Moore, senior currency strategist at Royal Bank of Canada.

“I think the next cut will be driven by a little more evidence of what the impact is and, specifically, evidence that the impact of oil is a little bit stronger than what the BoC has in their forecast now.”

The bank’s efforts to boost the economy are in contrast with a U.S. Federal Reserve that is expected to raise rates this year, possibly in June.

That should provide more fuel for the greenback’s rally to the detriment of the Canadian dollar.

“Slowly but surely the market focus is going to shift away from the timing of the first hike from the Federal Reserve and more toward the pace or the trajectory of Fed rate hikes,” said Bipan Rai, director of foreign exchange strategy at CIBC World Markets.

“That’s going to be the dominant arbiter of where price action heads thereafter,” said Rai, who expects the Canadian dollar to average close to C$1.30 for the second and third quarters.

Polling by Swati Chaturvedi and Khushboo Mittal in Bengaluru Editing by W Simon

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