May 7, 2015 / 2:43 PM / in 3 years

Canadian dollar to reverse gains on Fed-driven greenback rally: Reuters poll

BENGALURU/OTTAWA (Reuters) - The Canadian dollar’s recent rally is nearly over, with forecasters expecting higher interest rates south of the border to drive a resurgence in the greenback and take the loonie back toward its lows of the year, a Reuters poll found.

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 Canadian dollar CAD= - which recently has been highly sensitive to the price of oil, a major Canadian export - lost 20 percent from its peak last July to hit a six-year low in March.

From that low, however, the loonie has risen almost six percent, helped by a rebound in oil prices, a string of disappointing U.S. economic data and a more upbeat outlook from the Bank of Canada.

Even though the currency will continue to find support from higher crude prices in the near term, it will slip again once the timing of the Federal Reserve’s first U.S. interest rate hike in nearly a decade becomes more clear.

“It is more of U.S. dollar strength, really, than Canadian dollar weakness,” said CIBC senior economist Andrew Grantham.

The median forecast from 45 foreign exchange strategists has the Canadian dollar CAD=D4 trading at C$1.22 per U.S. dollar, or 82 U.S. cents, in a month, weaker than the C$1.2072 it closed at on Tuesday.

The loonie is expected to weaken further, hitting C$1.25 in three months and C$1.27 in six months, trading not far from there at C$1.26 in 12 months. The currency dropped to C$1.2835 in mid-March, its low for the year so far.

Interest rate differentials will matter in the near term.

The Fed is expected to lift rates soon, but it is looking more likely now that the central bank will wait until later in the year, likely September, rather than June.

By contrast, the Bank of Canada shocked markets with a rate cut in January and is seen staying on the sidelines long after the Fed starts to hike, which will also clip the loonie’s wings.

“Interest rate hikes in Canada will be a long way off,” Grantham said. “Rate hikes (will) come a bit earlier than markets expect in the U.S. (so) we will see the Canadian dollar give back some of its recent strength.”

Much will also depend on whether the economy picks up in the second half of the year as the BoC is forecasting. First-quarter growth stalled, partly on the impact from cheaper oil, but that is expected to dissipate soon.

Still, not everyone is optimistic.

“It feels like we’ve set ourselves up for disappointment here,” said Mazen Issa, senior Canada macro strategist at TD Securities, which is currently the fifth most accurate forecaster on the Canadian dollar on the 12-month horizon.

BoC Governor Stephen Poloz is expecting non-energy exports and a strengthening U.S economy to help drive that second-half rebound. While many claim that a weaker Canadian dollar is good news for exports, there is little evidence to support that.

Polling by Siddharth Iyer and Aaradhana Ramesh; Editing by Chizu Nomiyama

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