Canadian Dollar Rises to 11-Yr High on Prospect for Rate Boost

By Sangeetha Ramaswamy –
Canada’s dollar rose to the highest in more than a decade against the U.S. dollar on speculation the Bank of Canada will raise its target interest rate two more times this year.
The central bank’s rate boost Sept. 8 was the first in 17 months. It lowered rates three times since January to help exporters adjust to the currency’s 21 percent surge last year. The currency is up 3 percent since a Bank of Canada official indicated on Aug. 23 that the bank would begin a cycle of rate increases.

“The focus at the moment is on interest rates,” said Monica Fan, London-based global head of foreign-exchange strategy at RBC Capital Markets, a unit of Canada’s biggest bank by assets. “We’re bullish on the Canadian dollar provided we continue to see tightening by the Bank of Canada.”
The currency rose to 78.88 U.S. cents at 8:45 a.m. in Toronto from 78.64 U.S. cents yesterday, the highest since May 1993. Until today, the currency’s most-recent high had been 78.85 U.S. cents on Jan. 9. It closed above 78 U.S. cents on Sept. 22 for the first time since Jan. 13. One U.S. dollar buys C$1.2679.
Last week, the Canadian dollar climbed 1.8 percent, the most since the week ended July 2.
The Canadian dollar may strengthen to 80 U.S. cents, or C$1.25 per U.S. dollar, should it hold past C$1.2765, where sell orders are clustered, said Steven Butler, senior currency trader in Toronto at Bank of Nova Scotia, Canada’s third-biggest bank by assets. RBC predicts C$1.26 by year-end, Fan said.
Weaker Exports
Five days after the currency reached its Jan. 9 high, a government report showed the country’s November trade surplus shrank more than forecast.
“The rapid appreciation of the Canadian dollar against the U.S. currency has cut into the overall growth of aggregate demand for Canadian goods and services through weaker exports and increased imports,” the bank said in a statement accompanying its Jan. 20 decision to lower rates.
Now, comments from policy makers indicate the central bank is on a path to boost its 2.25 percent target interest rate further this year.
“We will need to reduce the amount of monetary stimulus in the economy to avoid a buildup of inflationary pressures,” Deputy Governor David Longworth said on Aug. 23.
Governor David Dodge echoed those remarks in a Sept. 20 speech. “Indeed, the bank judges that the Canadian economy is now operating close to its production capacity,” Dodge said.
An Aug. 31 report showed economic growth in the second- quarter was the most in two years. Canada releases July GDP data Sept. 30.
‘Feel-Good Factor’
“One of the attractions of the Canadian dollar currently is the expectation of accelerating growth going into 2005, which provides an important feel-good factor for U.S. dollar bears involved in this particular cross,” wrote Goldman Sachs Group Inc. global markets economist Thomas Stolper in London, in a daily research note to clients yesterday.
Canadian importers are less concerned about declines in the Canadian dollar, said currency traders including Jack Spitz, director of foreign exchange in Toronto at National Bank of Canada, the country’s sixth-biggest bank by assets. A weaker dollar makes imports more expensive.
More Room
Futures contracts betting on the Canadian currency’s gain “are still not at extraordinary levels,” RBC’s Fan said, indicating investors have more room to put money on an increase.
The latest data from the Washington-based Commodity Futures Trading Commission showed that so-called net longs were 39,400, from 44,700 in the previous week, which was the highest since November 1996.
The yield on the Canadian bankers’ acceptance futures contract expiring Dec. 13 is 2.805 percent, suggesting the chances of rate increases are 100 percent for the Oct. 19 meeting and about 80 percent for the Dec. 7 meeting, according to IDEAglobal research. It’s up 1.5 basis points today.
Bankers’ acceptance futures settle at Canada’s three-month lending rate, which averaged 19 basis points above the central bank’s target rate since Bloomberg started tracking the gap in 1992.
Last year, investors snapped up the Canadian dollar to buy the country’s debt as the yield difference with the U.S. averaged 82 basis points. Ten-year bond yields in Canada, which move inversely to prices, on Sept. 22 posted a gap of 56 basis points over their U.S. counterparts, the biggest since Nov. 27. A basis point is 0.01 percentage point.
Yield Gap
Canadian 10-year yields are 51 basis points higher than those in the U.S. The yield gap turned negative on May 10, on speculation interest-rate increases in the U.S. would outpace those in Canada this year. On Sept. 22, the benchmark 10-year U.S. Treasury note’s yield traded below 4 percent for the first time since April.
At the latest meeting on Sept. 21, the U.S. Federal Reserve stuck to its pledge to increase its target rate at a “measured” pace. The Fed lifted rates by 25 basis points, or 0.25 percentage point, at each of the last three meetings, to 1.75 percent. The U.S. is Canada’s biggest trading partner.
Canadian policy makers raised the target rate from 2 percent to prevent an accelerating economy from sparking inflation. The annualized core-inflation rate, which subtracts eight items including food and energy, was 1.5 percent in August, compared with 1.9 percent in July. The central bank targets 2 percent.
Dodge said last week that the bank predicts core inflation will “gradually” move up to 2 percent in 2005.
Source: Bloomberg News