Fundamental Forecast for Canadian Dollar: Bullish

The Canadian dollar continued to retrace the decline from back in May, and the appreciation in the loonie may accelerate in the following week should the Bank of Canada show an increased willingness to raise the benchmark interest rate off of 1.00%. According to Credit Suisse overnight index swaps, market participants widely expect the central bank to retain its current policy next week, but see borrowing costs increasing by nearly 50bp over the next 12-months as growth and inflation gather pace.

Indeed, a report released by the central bank earlier this week showed a net 53% of the businesses surveyed intend to increase hiring over the next 12-months, which marked the highest reading since recordkeeping began in 1998, and the ongoing improvement in the labor market may encourage the BoC to toughen its stance against inflation as price growth expands at the fastest pace since 2003. At the same time, the senior loan officer survey reinforced an improved outlook for the region as lending standards for businesses eased in the second-quarter, and private sector activity looks poised to pick up over the remainder of the year as the economic recovery becomes increasingly broad-based. In light of the recent developments, BoC Governor Mark Carney may drop his pledge to ‘carefully consider’ future rate hikes, and the central bank head may see a case to increase borrowing costs faster than initially warranted as economic activity accelerates. However, as the central bank sees a slowdown in the April to June period, Mr. Carney may strike a balanced tone for future policy, and the accompanying statement may highlight the dampening effect of the appreciation in the local currency as the board sees inflation to fall back towards the 2% target in the following year.

As the USD/CAD maintains the downward trend carried over from back in 2009, the pair looks poised to threaten the rebound from May (0.9445), and the Canadian dollar may continue outperform against its U.S. counterpart as interest rate expectations gather pace. In turn, the exchange rate may fall to a fresh record-low in the coming days, but a shift in risk-taking behavior could spark a reversal in the dollar-loonie as the reserve currency benefits from safe-haven flows.

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