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Loonie will dive, Bank of Canada will cut rates: Capital Economics

A loonie is pictured in Vancouver on April, 2014. Canada’s annual inflation rate accelerated to two per cent last month as higher costs for airfares and fresh vegetables offset cheaper prices at the pump. (THE CANADIAN PRESS/Jonathan Hayward)

The Canadian dollar will curtail its strong start to 2019, reversing course to US$0.72 cents this year, according to London-based Capital Economics.

The loonie has climbed about four per cent against the greenback since the start of the year, making it one of the best performing global currencies.

Rebounding oil prices and a more dovish U.S. central bank have helped lift the loonie, but Capital Economics analyst Stephen Brown expects those gains will be short-lived.

“A softening economy, slow wage growth and a drop back in oil prices are all reasons to doubt that the loonie’s recent strong run will be sustained,” he wrote in a research note on Wednesday. “We see the currency declining to $0.72 this year.”

The discount on Western Canadian Select oil, the primary grade from Canada’s energy patch, has narrowed to $9 per barrel versus U.S. benchmark West Texas Intermediate. The spread reached the $50 range in late 2018, prompting Alberta’s Premier Rachel Notley to order a production cut to absorb excess supply and boost prices.

Canada continues to produce more oil than it can ship by pipeline or consume at home. Shipments by rail remain near all-time highs, but the executives at Suncor Energy Inc. (SU.TO) and Imperial Oil Ltd. (IMO.TO) have recently warned that crude-by-rail at current prices is not financially sustainable.

“Canadian oil price discounts will have to widen back to $15 per barrel to incentivize that shipping,” Brown wrote, adding that weak global demand and an expected pick-up in U.S. production will be negative for the energy-aligned loonie.

Brown also sees the North American monetary policy environment shifting in favour of the U.S. dollar, with robust economic data in that country upping the chances the Federal Reserve will “more likely than not” raise its benchmark rate.

“Whereas troubles in the housing and energy sectors mean that the Bank of Canada’s tightening cycle is over,” he wrote. “In fact, we expect the Bank of Canada’s next move to be an interest rate cut”

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