Loonie takes aim at 94 cents US

The Canadian dollar tested six-month highs Friday, but analysts say they don't expect the loonie's recent strength to be the new normal.

The Canadian dollar rose almost three-tenths of a cent to close at 93.80 cents US Friday — its fourth consecutive day trading higher following a strong inflation report last Friday. That's its highest level since the first week of January.  

The loonie hit a 2014 low of 88.94 cents on March 20, after a steady slide down from 98 cents in September and 96 cents as recently as November.

But don't expect the loonie to keep rising, foreign exchange experts say.

"The Canadian economic backdrop is not strong enough to withstand CAD/USD parity," Camilla Sutton, chief foreign exchange strategist at Scotiabank, told CBC News.

"A strong currency would weigh on exports and suppress inflation at a time when the economy is already fairly vulnerable and would relieve any pressure on the [Bank of Canada] to increase interest rates, likely fuelling financial stability risk."

Higher oil prices, inflation fuel loonie

Sutton also notes that investors had built up a large short position in the Canadian dollar during the fall and early winter. "This has fallen victim to short covering, driving a more dramatic move in [the Canadian dollar]."  She sees the Canadian dollar as being "well overvalued."

Oil prices, which have moved above $105 US a barrel, and Canada's May inflation figures, which showed annual inflation rising at an unexpectedly high 2.3 per cent, have also boosted the loonie.

"Higher oil prices (in the wake of the Iraq crisis) and higher inflation readings (with their presumed dimming of [Bank of Canada] rate cut prospects) helped strengthen the Canadian dollar to ... the strongest level since the start of the year," says a rate forecast from Michael Gregory, deputy chief economist with BMO Capital Markets.

"It also helped that the end-of-May release of Canadian GDP data revealed relatively stronger performance than south of the border."

BMO forecasts that the loonie will weaken dramatically through 2015, with a U.S. dollar costing $1.15 Cdn to buy by the end of that year. That converts to an exchange rate of 87 cents US.

Weak U.S. data

It's clear that broad weakness in the U.S. dollar is playing a major role in the Canadian dollar's recent strength.

According to data from Bloomberg, the American currency slipped Friday to its lowest level against a basket of major currencies in seven weeks.

The greenback's slump this week followed news that the U.S. economy contracted in the first quarter at an annual rate of 2.9 per cent.

"It's been a bad week in terms of the data released from the U.S., which has shown that the economy's a lot weaker than people anticipated," Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ, told Bloomberg.

"That's prompting investors to downgrade their outlook for growth this year in the U.S. and that's leading to lower yields and a lower [U.S.] dollar."

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