Canadian Dollar Poised to Test 2009 High on Risk Appetite

[B][B]Canadian Dollar Poised to Test 2009 High on Risk Appetite[/B][/B]

[B]Fundamental Forecast for Canadian Dollar: Neutral[/B]

The Canadian dollar was the best performer against the greenback this week, advancing nearly 2 percent to reach a two-month high following the improved outlook held by the Bank of Canada, and the USD/CAD looks poised to test the yearly low (1.0783) over the following week as the loonie continues to benefit from the rise in risk appetite. Meanwhile, the central bank held the benchmark interest rate at the record-low of 0.25% earlier this week and raised its growth forecast for the world’s eighth largest economy as policymakers expect an economic recovery later this year.

According to the policy statement, the bank predicts GDP to contract an annual rate of 2.3% this year amid an initial forecast for a 3.0% drop in the growth rate, and expects inflation to reach the 2% target in the second-quarter of 2011, which is three-months ahead of its previous projection. In addition, policymakers reiterated ‘conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010,’ and the comments suggests that monetary policy will remain accommodating as the nation faces its worst economic downturn in over half a century. Moreover, the BoC monetary policy report reinforced the improved outlook held by the central bank as Governor Mark Carney anticipates the economy to emerge from the recession in the second-half of the year, and forecasts the growth rate to expand at an annualized rate of 1.3% from July through September. Accordingly, Mr. Carney went onto say that central bank’s provisional commitment to keep borrowing costs at the record-low until June of the following year is ‘not a guarantee’ as the fiscal stimulus works its way through the real economy, and long-term expectations for higher interest rate may drive the Canadian dollar higher over the second-half of the year as investors anticipate the central bank to tighten policy over the next 12 months.

At the same time, the central bank head said that ‘this recovery isn’t as robust as previous recoveries have been,’ and stated that the recent appreciation in the exchange rate could hamper the prospects for a sustainable recovery as it reflects a ‘generalized weakening of the U.S. dollar’ paired with higher commodity prices. Furthermore, Governor Carney stated that the volatility in the nation’s currency is an important risk to the economy, and forecasts the exchange rate to average $0.87 through 2011. Nevertheless, as the economic docket for the following remains fairly light, risk trends are likely to dictate price action for the USD/CAD however, as the monthly GDP is expected to fall 0.4% in May, a dismal growth reading could lead the pair to retrace the sharp decline from earlier this week as investors weigh the outlook for a sustainable recovery. - DS