Canadian dollar 2014 forecasts upgraded at RBC; Pace of declines in CAD forecasted to slow

The US dollar to Canadian dollar end-2014 forecast has been raised at RBC; however the target exchange rate is still far from current levels.

This note courtesy of RBC: The sharp deterioration in the Canadian dollar that kicked off in October when the Bank removed its tightening bias built momentum in January.

Since October 23, 2013, the Canadian dollar lost 6.8% against the US dollar with two-thirds of the drop occurring in January alone.

The combination of the growing, though limited, expectations that the Bank may cut rates in 2014, stagnant commodity prices, and a recovery in positive sentiment toward the US dollar had a hand in the Canadian dollar’s drop.

We expect that rate cut expectations will evaporate as the pace of economic growth accelerates, which will remove one of the downward pressures on the currency.

The trend of a steadily weakening Canadian dollar against its US counterpart is likely to remain in place although the pace of decline will slow.

Incorporating January’s drop into our forecast resulted in a shift lower of our year-end target to C$1.15 from C$1.09 in our previous forecast with the year-end 2015 forecast shifted to C$1.18 from C$1.15.

NOTE: Note: All CAD quotes here refer to the wholesale spot market. Your bank will charge a spread at their discretion when passing on a retail rate. However, an independent FX provider is so well placed on the market that they are able to deliver you up to 5% more currency. Please learn more here.

The Bank of Canada took a marginally more upbeat view of the growth outlook in its January Monetary Policy Report and boosted the 2014 growth projection to 2.5% from 2.3%.

Despite this upgrade, the Bank lowered its inflation forecast profile and emphasised that the risk of inflation remaining below target had become increasingly important.

With that said, the Bank maintained the 1% overnight rate, presenting this as the best course to balance the downside risks to the inflation outlook with upside risks being generated from keeping interest rates at very low levels.

The improvement in the global, and in particular US, outlook lays the groundwork for stronger Canadian growth in 2014 backed by a upgraded forecast for net exports (the Bank doubled its forecast for the contribution from net trade in 2014 in the January update).

The Bank acknowledged that the US economy grew at a faster than projected clip in the second half of 2013 and is likely to maintain improved momentum in 2014.

This assessment is in line with our view that a stronger US economy will result in the long-awaited strengthening in demand for Canadian exports with the sharp weakening in Canada’s dollar against the US dollar providing additional support.

See the Canadian dollar forecast for 2014 below: