Loonie likely to face downward pressure

The Canadian dollar, already the worst performing primary currency, could be in for even more downward pressure depending on what the Bank of Canada has to say at its next scheduled interest rate announcement on Wednesday.

There is no doubt the central bank will keep its key rate at one per cent, where it’s been since September 2010.

But the central bank’s dovish stance on rates, together with subpar economic data, has helped push the currency down almost three cents since the start of the year to September 2009 levels. And that was on top of a six per cent slide in 2013.

“A lot of bad news got priced into the dollar very quickly at the start of the year and so now most will be in wait-and-see mode to see if there is any change in the bank’s view or rhetoric,” said Doug Porter, chief economist at BMO Capital Markets.

“So I think (markets) will be looking very closely for any changes in tone in the bank’s decision and their monetary policy report.”

The bank has recently signalled that it’s in no hurry to raise rates, leaving economists to expect that rate hikes aren’t in the cards until 2015.

Poor economic data has also weighed on the Canadian dollar, including reports earlier this month showing a worsening trade deficit and the loss of 46,000 jobs in December. And that has led some on currency markets to think that the bank could actually move rates lower.

“I would say a lot of international observers believe that there is a very real chance that the Bank of Canada could cut interest rates at some point, where most domestic commentators think that is pretty farfetched,” he said.

Another major reason for the loonie’s slide the U.S. Federal Reserve’s move to start cutting back on its stimulus program involving the purchase of massive amounts of bonds every month.

The Fed’s latest exercise of quantitative easing, involving the purchase of $85 billion US of bonds monthly, has kept long-term rates low. The central bank moved last month to start cutting those asset purchases by $10 billion a month initially.

That has pushed the U.S. dollar higher and Porter calls this development a major reason for the loonie’s fall.

“I think that is at least half of the story of the Canadian dollar weakness — the fact that the Fed is beginning to taper QE3, the U.S. economy is picking up and there is more confidence in the U.S. generally these days,” he said.

“So we are seeing that U.S. dollar (effect) against a number of currencies.”

Adding it all up, it’s hard to see how the loonie can avoid moving even lower.

Porter expects the Canadian dollar to decline further before making a modest comeback in the second half of the year.

“But even so, we are still expecting the currency to finish the year at just below 91 cents,” he said.

Meanwhile, investors will continue to focus on another heavy slate of fourth-quarter earnings next week, particularly from the U.S.