Fundamental Forecast for Canadian Dollar: Neutral

The Canadian dollar struggled to hold its ground against its U.S. counterparts even as currency traders showed a bullish reaction to the Bank of Canada rate decision, but the sharp pullback from 0.9851 may gather pace as the economic docket is expected to reinforce an improved outlook for the region. Indeed, the BoC said monetary stimulus will have to be “eventually withdrawn” after holding the benchmark interest rate at 1.00% in May, and extended its outlook for above-target inflation as the central bank sees price growth holding above 3% “in the short-term.” In turn, a positive batch of fundamental developments should help the loonie to regain its footing in the week ahead, and the near-term rally in the USD/CAD may come under pressure as growth in Canada outpaces the recovery in the world’s largest economy.

A rebound in business spending paired with a second consecutive rise in Canadian employment should help to prop up the local currency, and the central bank may see scope to normalize monetary policy further in the second-half of the year as growth and inflation gather pace. At the same time, the trade surplus is expected to expand for the fifth month in April, but the figures may miss market expectations as the marked appreciation in the loonie dampens foreign demands. As the strong Canadian dollar presents “greater headwinds” for the economy, we may see the BoC retain its pledge to “carefully consider” future rate hikes in the second-half of the year, and the balanced tone held by the central bank could weigh on interest rate expectations as policy makers continue to highlight the “material excess supply” within the real economy. According to Credit Suisse overnight index swaps, investors see borrowing costs in Canada increasing by more than 50bp over the next 12-months, amid projections for a 100bp rise back in May, and interest rate expectations may deteriorate further in June should the slew of economic event risk fall short of market expectations.

As the USD/CAD continues to trade within the upward trending channel carried over from the previous month, the exchange rate could be carving out a major bottom in the first-half of 2011, and a dismal batch of data will certainly expose the 78.6% Fibonacci retracement from the 2007 low to the 2009 high around 0.9900. However, positive developments out of Canada could threaten the current trend in the pair, and the data could fuel a rebound in interest rate expectations, which should help the loonie to recoup the losses from the previous month.

DailyFX provides forex news on the economic reports and political events that influence the forex market.