Canadian dollar forecasts turn less bullish as economy stumbles

© Reuters. FILE PHOTO: A Canadian dollar coin, commonly known as the "Loonie", is pictured in this illustration picture taken in Toronto January 23, 2015. REUTERS/Mark Blinch

By Fergal Smith

TORONTO (Reuters) - There is less upside for Canada's dollar over the coming year, according to analysts who are weighing the effect of a surprise contraction in the economy and signs of a cooler housing market on the Bank of Canada's policy outlook, a Reuters poll showed.

With about 68% of its population fully vaccinated against COVID-19, Canada's economy could be positioned better than some others to cope with a fourth wave of the virus.

Still, the economy surprisingly shrank in the second quarter, when lockdowns were in place, and likely had far less momentum than had been expected heading into the summer, data showed on Tuesday.

The Bank of Canada had expected second-quarter growth of 2%, so the data could cause it to raise its estimate of the economy's spare capacity.

That's crucial because the BoC has pledged to keep interest rates on hold until slack is absorbed, which would occur in the second half of 2022 according to the central bank's latest forecast.

The data "does create a bit of a question mark about just how quickly the Bank of Canada will raise interest rates going forward," said Shaun Osborne, chief currency strategist at Scotiabank.

"It does raise the risk of maybe a slightly more dovish than we are currently expecting Bank of Canada, at least on the messaging front."

The BoC is due to make an interest rate decision next Wednesday but an update of its economic projections is not expected until October.

Meanwhile, a snap Canadian election has been called for Sept. 20 but analysts see little difference between the major parties on fiscal and economic policy and doubt it will have much lasting impact on the currency.

The median forecast of 36 strategists, polled Aug. 30-Sept. 2, was for the Canadian dollar to strengthen around 1.6% in three months to 1.2350 per U.S. dollar, or 80.97 U.S. cents, compared to 1.2250 in last month's poll.

It was then expected to rise further to 1.22 in a year's time. In August, the forecast was 1.21.

The currency has gained 1.4% since the start of the year, the best performance among G10 currencies, helped by higher commodity prices. Canada is a major producer of commodities, including oil.

But oil has pulled back from a July peak, with the outlook for demand becoming more uncertain and OPEC raising output.

A combination of more oil supply and weakening residential investment could weigh on the Canadian dollar next year, said Stephen Brown, senior Canada economist at Capital Economics.

Housing investment boomed during the pandemic but the market has cooled from its March peak, while a recent Reuters poll showed property market analysts expect prices to come off the boil next year.[CA/HOMES]

The Bank of Canada "will not be as eager to raise rates" should the slow down in housing activity continue, Brown said.

(For other stories from Reuters foreign exchange polls:)