Fundamental Forecast for Canadian Dollar: Neutral

The Canadian dollar may continue to gain ground against its U.S. counterpart as interest rate expectations gather pace, but currency traders may show a mixed reaction to the data scheduled for the following week as the economic recovery in the region abates. The marked rise in the consumer price index has certainly fueled speculation for higher borrowing costs, and the Bank of Canada may adopt a hawkish tone for monetary policy as inflation expands at the fastest pace since 2003.

According to Credit Suisse overnight index swaps, market participants are pricing the interest rate to increase by more than 50bp over the next 12-months, which has nearly doubled from June, and the BoC may see scope to normalize monetary policy further in 2011 as the headline reading for inflation continues to diverge from the 2 percent target. Indeed, the key development coming out of Canada next week will be the labor report for June, which is expected to show another 12.5K expansion in employment and the ongoing improvement in private sector activity could further instill expectations for a rate hike later this year. However, market participants may show a bearish reaction to the Ivey PMI report as business spending is projected to expand at a slower pace, and the development could spark a near-term correction in the USD/CAD following the largest weekly decline since July 2010.

However, should the slew of data top market expectations, we are likely to see the recent appreciation in the loonie accelerate, and the USD/CAD may continue to push lower in the second-half of the year as it maintains the downward trend carried over from 2009. As the dollar-loonie retraces the rebound from May, the exchange rate looks poised to make a run at the year low (0.9445), and the pair may threaten the 2007 low at 0.9056 as the major trends continues to call for further declines.

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