By Fergal Smith
TORONTO (Reuters) - The Canadian dollar is set to rally over the coming 12 months as pressure grows on the Bank of Canada to resume its interest rate hiking campaign and some of the appeal of the U.S. dollar potentially fades, a Reuters poll showed on Wednesday.
While the loonie was expected to give back some of its recent gains over the coming three months, edging 0.6% lower to 1.3467 per U.S. dollar, or 74.26 U.S. cents, it was then expected to rally to 1.29 in a year, the median forecast of nearly 40 currency analysts showed.
A move to 1.29 per U.S. dollar would be a gain of 3.9% and matches the forecast in last month's poll.
"The main bullish development is the fact that for a while the Bank of Canada has been on pause and now it is looking increasingly likely that it is going to resume hiking rates," said Jay Zhao-Murray, market analyst at Monex Canada Inc.
Money markets see a near 50% chance of the Canadian central bank raising its benchmark rate later on Wednesday after leaving it on hold at a 15-year high of 4.50% since January. A hike is fully priced in by the next meeting in July.
"It's a surprisingly strong economy here in Canada," Zhao-Murray said. "You take a look and you see a big surge in the housing market. You see a resurgence in inflation."
The BoC is counting on slower economic growth to return inflation to its 2% target. But Canada's economy grew at an annualized rate of 3.1% in the first quarter, eclipsing the BoC's forecast of 2.3%, and likely accelerated further in April.
Canada's employment data for May, due on Friday, will offer further evidence about the relative strength of the economy.
Another key contributing factor to how the Canadian dollar will perform is the outlook for the U.S. dollar as investors bet the Federal Reserve will pause its tightening campaign as soon as next week.
"We anticipate the Canadian dollar will strengthen modestly over the next year as the U.S. dollar loses a bit of its lustre," said Benjamin Reitzes, Canadian rates & macro strategist at BMO (TSX:BMO) Capital Markets.
"The Fed backing off from hikes later this year and eventual rate cuts next year are expected to weigh on the greenback and, in turn, lift the Canadian dollar modestly."
A shift to Fed rate cuts would likely be supportive of the global economy. Canada is a major exporter of commodities, including oil, so the loonie is particularly sensitive to the global economic prospects.