May 3, 2017 / 4:59 PM / 3 months ago

Canadian dollar to strengthen after 'perfect storm': Reuters poll

4 Min Read

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 weather a "perfect storm" to regain some ground over the coming months, a Reuters poll showed on Wednesday, as a pickup in the domestic economy could prod the Bank of Canada to raise interest rates by next year.

The loonie CAD=D4 has lost 2 percent against the greenback this year, the weakest performance among G10 currencies. On Tuesday it touched a 14-month intraday low at C$1.3758.

Speculators have also ramped up bearish bets on the loonie to the most since February 2016.

However, a survey of more than 50 foreign exchange strategists shows they expect the Canadian dollar will recover to C$1.3500 in one month and firm further to C$1.3400 in a year, according to their median forecast.

The loonie is under pressure from myriad factors, including the fall in the price of crude oil, a major Canadian export.

Another headwind is the monetary policy divergence between the U.S. Federal Reserve, which began raising interest rates in December 2015, and the Bank of Canada, which has not hiked them since 2010.

Also weighing on the currency is the uncertain fate of the North American Free Trade Agreement, which binds Canada, the United States and Mexico. U.S. President Donald Trump said last week he would terminate it if negotiations on the accord became "unserious."

"Right now it is a perfect storm for the Canadian dollar, you have a dovish Bank of Canada; you have soft oil prices; you have import duties being slapped by the U.S. on Canadian lumber which gets investors worried that it could lead to worse things like other trade barriers," said Krishen Rangasamy, senior economist at National Bank Financial.

He expects the currency to turn the corner and firm to C$1.3300 in 12 months as current strength in the economy feeds inflationary pressures.

Economists say Canada's gross domestic product may have grown as much as 4 percent at an annualized rate in the first quarter following a strong expansion in the second half of 2016.

"Our view is that the currency has overreacted to these events and will strengthen from here," said Andrew Grantham, senior economist at CIBC Capital Markets. "We think this is the weaker end of the range that we are going to see over the next 12 to 18 months."

He added: "We have seen very strong growth in the Canadian economy ... which has seen us pull forward (to the first quarter of 2018) our expectations for the Bank of Canada to hike interest rates."

But the bank has played down the sustainability of recent growth.

In addition, the funding crisis at mortgage lender Home Capital Group Inc (HCG.TO) may spark a welcome cooling in Canada's housing market and take pressure off the central bank to tighten monetary policy.

Expectations of a central bank interest rate hike this year have dwindled, data from the overnight index swaps market shows. As recently as Friday, there was a one-in-four chance implied of a rate increase. BOCWATCH

Still, strategists expect the Bank of Canada to eventually adopt a more hawkish tone.

"There is a limit to how long you can stick to a negative story when things are improving," National Bank Financial's Rangasamy said.

U.S.-Canadian monetary policy divergence should narrow as Canada's economy reaches full capacity in the first half of 2018, said Eric Viloria, currency strategist at Wells Fargo.

Polling by Indradip Ghosh and Vivek Mishra; Editing by Ross Finley and W Simon

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