Fundamental Forecast for Canadian Dollar: Neutral

The Canadian dollar may depreciate further in the week ahead as currency traders scale back their appetite for risk, and the USD/CAD may continue to retrace the sharp decline from earlier this year as the Bank of Canada maintains a dovish outlook for future policy. With the economic docket expected to highlight a weakened outlook for the region, the fundamental developments could exacerbate the recent weakness in the loonie as investors curb speculation for a rate hike in the first-half of 2011.

BoC Governor Mark Carney expects economic activity to slow in the second quarter, largely driven by the marked appreciation in the local currency, and said that the three-months through June will be ‘an interesting’ period for the region during an interview with CNBC. Housing starts in Canada are expected to increase at an annualized pace of 184.0K in April following the 188.8K expansion in the previous month, while the prices for new homes are projected to increase 0.3% in March after climbing 0.4% in the month prior. As the fresh batch of data is expected to reinforce a weakened outlook for growth and inflation, the rebound in the dollar-loonie could gather pace in the days ahead, and the pair may make another run at the 100-Day moving average at 0.9803 as it clears the 50-Day SMA for the first time since March.

However, market participants continue to see borrowing costs in Canada increasing by nearly 100bp over the next 12-months according to Credit Suisse overnight index swaps, and the USD/CAD may consolidate over the near-term as the sharp rebound in the exchange rate fails to produce a test of the April high at 0.9720. In turn, we may see a small correction in the dollar-loonie going into the following week, and the exchange rate may trade within a broad range ahead of the next BoC policy meeting on May 31 as the outlook for the Canadian currency remains torn between the dovish stance held by the central bank and market speculation for higher interest rates.

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