December 1, 2016 / 2:22 PM / 9 months ago

C$ set to weaken as rate divergence upstages oil rally: Reuters poll

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

TORONTO (Reuters) - The Canadian dollar will extend recent losses against its U.S. counterpart over the coming months as expected monetary policy divergence overshadows higher prices for oil, one of Canada's major exports, a Reuters poll found.

The currency is forecast to weaken to C$1.352 in one month, versus C$1.3429 at Wednesday's close, the poll of 50 foreign exchange strategists showed on Thursday.

Further losses are expected, with strategists projecting that the loonie will hit C$1.360 in six months and trade at C$1.370 in 12 months, much weaker than the previous month's consensus of C$1.330 and C$1.310, respectively.

"It (a weaker Canadian dollar) mainly reflects our expectation that the U.S. dollar will be broadly stronger as U.S. rates continue to move higher from here," said Daniel Katzive, head of FX strategy North America at BNP Paribas.

Investors expect the U.S. Federal Reserve to raise interest rates in December and continue to hike in 2017. In contrast, the Bank of Canada is expected to stand pat until 2018, a separate Reuters poll shows.

Hendrix Vachon, a senior economist at Desjardins, said he expects that the interest rate spread between Canada and the United States will continue to widen.

A wider spread reduces investor incentive to buy lower-yielding Canadian bonds, trimming demand for Canadian dollars.

The Bank of Canada's dovish tone will add to pressure on the Canadian dollar, Vachon said.

In October, the central bank downgraded its growth outlook for Canada's economy and acknowledged that it considered an interest rate reduction before holding its policy rate steady at 0.50 percent. It last cut rates in July 2015.

The market is underestimating the prospect of further interest rate cuts from the Bank of Canada, some economists said, as an uncertain outlook for the North American Free Trade Agreement after the U.S. election risks derailing an expected pick-up in Canada's business spending.

The price of oil soared on Wednesday to its highest in a month as some of the world's largest producers agreed to curb production for the first time since 2008. [O/R]

But higher oil prices won't be enough to compensate for the wider interest rate spreads between Canada and the United States, Vachon said.

The Canadian dollar's normally tight link with the price of oil broke down in September. On Wednesday, the three-month rolling correlation was barely above zero, according to Reuters data.

"We observe that the interest rate spread has higher correlation (than oil)," said Eric Viloria, currency strategist at Wells Fargo.

"We have seen higher U.S. Treasury yields. That has been supportive of the U.S. dollar. But we think there is room for further U.S. dollar strength if the Fed continues to raise rates in the coming quarters."

Polling by Sujith Pai and Shrutee Sarkar; Editing by Ross Finley and W Simon

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