Canadian dollar seen rebounding as U.S. ties anchor domestic economy: Reuters poll

By Fergal Smith

TORONTO (Reuters) - Analysts are sticking to their bullish forecasts on the Canadian dollar for the coming year, maintaining that the currency is undervalued and could benefit from Canada's close economic ties with the United States, a Reuters poll found.

The Canadian currency has tumbled in recent days against its safe-haven U.S. counterpart as a global spike in long-term borrowing costs spooked investors.

On Wednesday, the loonie touched its weakest intraday level in six months at 1.3779 per U.S. dollar, or 72.57 U.S. cents, before clawing back some losses.

"Our forecast is that the Canadian dollar is undervalued relative to the U.S. dollar based on its long-term fundamentals and it should appreciate from here," said Jay Zhao-Murray, a market analyst at Monex Canada.

One measure of a currency's value is purchasing power parity (PPP), or the exchange rate that equalizes the purchasing power of different currencies. PPP for the Canadian dollar per U.S. dollar conversion is 1.225, the OECD's latest estimate, for 2022, shows.

The median forecast of 41 foreign exchange analysts in the Oct. 2-4 poll was for the loonie to strengthen 2.5% to 1.34 per U.S. dollar in three months, matching the forecast in a September poll. It was then expected to advance to 1.29 in a year, also matching last month's forecast and a gain of over 6.0%.

"For Canada, a big boon right now is just the strength in the U.S. ... We get some spillover effects from the United States," Zhao-Murray said.

Canada sends about 75% of its exports to the United States, including oil, which is up more than 30% from its May trough. The U.S. economy maintained a fairly solid pace of growth in the second quarter and activity appears to have accelerated this quarter.

Still, Canada's economy is likely to be particularly sensitive to higher borrowing costs after households borrowed heavily during the pandemic to participate in a red-hot housing market and due to a particularly short mortgage cycle.

That could mean the higher-for-longer interest rate outlook being priced into markets for both the Bank of Canada and the Federal Reserve is a headwind for the loonie and the currency could perform better once an easing cycle begins, analysts say.

"The Canadian dollar should gain a bit of traction when Fed cuts come into view," said Jimmy Jean, chief economist at Desjardins Group.

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