Canadian dollar to pull back over coming months as rate-driven rally fades: Reuters poll

By Fergal Smith

TORONTO (Reuters) - Canada's dollar is expected to weaken over the coming months, a Reuters poll of 47 foreign exchange strategists showed on Thursday, as a rally driven by expectations for higher interest rates runs out of steam and lower oil prices weigh.

The median forecast is for the currency to retreat in three months to C$1.32 to the U.S. dollar, or 76 U.S. cents, before recovering some ground to C$1.31 in about a year. It was trading on Wednesday at C$1.2960, nearly its strongest in 10 months.

The loonie has soared more than 6 percent since early May, boosted by a strengthening domestic economy and rising expectations the Bank of Canada will hike interest rates as early as next week.

The central bank's top two officials asserted in June that a pair of 2015 interest rate cuts had done their job in cushioning the economy from collapsing oil prices.

But the currency's rally may get long in the tooth if the Bank of Canada does not indicate it is prepared to tighten beyond taking back the two cuts from 2015, termed "insurance" at the time, by raising rates.

"Unless the (central) bank comes out overtly hawkish next week and the market starts pricing in a third hike for the coming year," it will be difficult for the Canadian dollar to strengthen further, said Bipan Rai, senior macro strategist at CIBC Capital Markets.

The central bank may want to see more progress on reaching its 2 percent inflation target before it goes further than taking back the insurance cuts, Rai said.

Inflation has held well below the target, even as Canada's economy grew at an annualized 3.7 percent rate in the first quarter after a strong expansion in the second half of 2016.

The drop in the price of oil, one of Canada's major exports, adds to the risk of a "near-term correction to the recent trend" for the Canadian dollar, said Nick Bennenbroek, head of currency strategy at Wells Fargo.

Oil has slumped 16 percent in price since the start of the year, including 4 percent on Wednesday after Thomson Reuters Oil Research data showed exports by the Organization of the Petroleum Exporting Countries climbed for a second month in June.

The latest Reuters oil poll showed analysts slashing price expectations for this year and next. [O/POLL]

'CLEAR AND PRESENT DANGER'

RBC Capital Markets chief technical strategist George Davis expects the Bank of Canada to hike in July and October and for the loonie to touch C$1.27 in the third quarter.

But he said that the rally will fade as the central bank pauses and as renegotiations of the North American Free Trade Agreement get underway.

Talks on NAFTA, which could start as soon as mid-August, could hurt Canada's economy as the Trump administration tries to win better terms for U.S. workers and manufacturers.

While NAFTA renegotiations are "the most clear and present danger," a slowdown in the country's housing market could also weigh on the country's economy due to elevated borrowing by Canadians, CIBC's Rai said.

The Bank of Canada had long said interest rates are too blunt a tool to tackle the country's housing market. But it may have finally decided to act and at least limit its role in fueling a potential bubble with low interest rates after home prices soared in Toronto and Vancouver.

(Other stories from the Reuters global FX poll:)

(Polling by Sujith Pai and Krishna Eluri; Editing by Ross Finley and Jeffrey Benkoe)