BMO Senior economist Benjamin Reitzes says a variety of factors, from an increasingly dovish tone from the Bank of Canada and further tapering action from the U.S. Federal Reserve, will continue to drag down the loonie.
“Look for the loonie to weaken to C$1.15 (87 U.S. cents) around mid-year or perhaps sooner, given the speed of the recent depreciation,” he said.
The loonie was slightly higher Thursday, up 0.18 of a cent at 89.64 cents U.S.
The report said the Canadian dollar isn’t likely to return to parity “any time soon” but a small rebound back to the low 90s may happen in the latter half of the year if there are no low-inflation induced rate cuts by the Bank of Canada.
“Since governor (Stephen) Poloz took the helm at the bank, each statement has become more dovish than the last,” Reitzes said. “He can’t go much further down that road without easing policy, and markets are pricing in slight odds of a rate cut this year.”
The outlook was one of the lowest loonie forecasts issued so far by a major bank. Most economists have predicted that the currency will fall to around 90 cents this year.
The Canadian dollar has seen its value against the U.S. dollar drop more than 10 cents over the past year. The fall has come amid moves by the U.S. central bank to scale back its stimulus measures, which has led U.S. bond yields to rise.
Meanwhile, the dovish tone on interest rates from the Bank of Canada has had the opposite effect, and has driven bond yields in Canada lower.
Earlier this week, the Fed cut back its bond purchases by another US$10 billion to $65 billion a month. It was the central bank’s second such move to cut back the program to help keep long-term interest rates low.
The Fed’s monthly bond purchases over the last few years has plumped up markets, but now that the stimulus is being pulled back, the U.S. dollar has strengthened on expectations of higher interest rates and a stronger economy.
Reitzes said the loonie is currently at “fair value” if based on factors such as commodity prices, which have also fallen in the past year.
“It’s clear that markets have soured on the loonie. Until expectations for commodity prices turn higher or the Bank of Canada changes gears toward more hawkishness, the risk is tilted toward more weakness than expected,” he said.
“That should bring a smile to exporters and some domestic retailers, but will markedly raise the price of travelling abroad and put a serious dampener on cross-border shopping enthusiasts.”