Fundamental Forecast for Canadian Dollar: Neutral

- Canadian Dollar Forecast to Decline on Sentiment Shift
- Canadian Dollar Remains Resilient, Japanese Yen Breaks Out

The Canadian dollar has continued to lose ground against the U.S. dollar, finishing as the fourth-worst performing G-10 currencies through Friday’s close. Looking ahead, the main focus for investors will be whether Canada will increase their key overnight borrowing costs to 0.50% from 0.25% at its rate decision meeting on June 1st. Indeed, markets are pricing in a rate hike next month as Governor Mark Carney recently dropped a “conditional commitment” to leave rates unchanged until July, while economic data this week gave the central bank more scope to begin increasing borrowing costs.

Taking a look at the economic docket this past week, we have seen the annual inflation rate accelerate in April as retailers saw sales increase at the fastest pace in five years, while the regions index of leading economic indicators advanced for an 11th straight month in April. Meanwhile, retail sales rose more than expected in March and the most since February 2005 as consumers contribute more than half of Canada’s 3.7 percent expansion this year. In the week ahead, the Canadian calendar is fairly light as market participants will turn to the house price index for the month of April, and the current account for the first quarter which is forecasted to come in at -$7.5 billion. However, price action may be subdued this week as speculators await the central bank rate decision next week. Going forward, the market is pricing in a cumulative 91.9 basis points worth of tightening over the next 12 months and a sixty eight percent chance that the central bank will raise rates at their June 1st meeting, according to the Credit Suisse Overnight index swaps.

If Canada does raise rates in two weeks, we may see a similar Australian recap in which the rate hike lead to a revision of higher yield forecasts. However, should the loonie raise borrowing costs, it would become the first out of the group of seven to raise its key overnight lending rate since last year’s recession. Nonetheless, as risk trends continue to dictate price action in the currency market due to fears of Greek debt contagion, we may see the U.S. dollar continue its northern journey against the Canadian dollar as the pair has recently broken above the 200-day SMA, which has formed as a key level of resistance since May 2009.

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