Canada Dollar Drops to Lowest in 3 Years on Below-Target CPI

The Canadian dollar plunged to the lowest level in three years after the inflation rate remained below the central bank’s target band for a second month.

The currency erased losses versus its U.S. peer as investors bet faster-than-forecast economic expansion in the U.S., Canada’s largest trade partner, will also boost growth north of the border. Canada’s legal tender fell for the fourth time in five weeks after the U.S. Federal Reserve said Dec. 18 it would begin cutting bond-buying next month. Bank of Canada Governor Stephen Poloz cited low inflation risks in dropping his bank’s bias to raise interest rates earlier this year.

“What you’re seeing is how resilient the Canadian dollar has been,” Brad Schruder, director of foreign exchange at Bank of Montreal, said by phone from Toronto. “This market was already very short the Canadian dollar and market participants are realizing that the Fed decision to begin tapering is reflective of the strength of the U.S. economy, and that will have a spillover effect on Canada.” A short position is a bet an asset will decline in value.

The loonie, as the Canadian dollar is known for the image of the aquatic bird on the C$1 coin, gained 0.3 percent to C$1.0635 per U.S. dollar at 5 p.m. in Toronto after touching C$1.0738, the lowest since May 2010. It fell 0.5 percent this week. One loonie buys 94.03 U.S. cents.

Crude, Bonds

Futures of crude oil added 0.4 percent to $99.14 per barrel in New York after touching $99.40, the highest since Oct. 22. The discount Canadian oil producers face for their crude compared to U.S. benchmarks narrowed to $23.50, the smallest since Aug. 16, according to data compiled by Bloomberg.

Canada’s benchmark 10-year government bond rose, with yields falling three basis points, or 0.03 percentage point, to 2.67 percent. The 1.5 percent security maturing in June 2023 added 25 cents to C$90.30.

The extra interest available in U.S. government 10-year bonds compared with their Canadian peers, a gauge of longer-term growth expectations, increased to 22 basis points, the biggest U.S. advantage since February 2011.

The cost to insure against further declines in the loonie versus its U.S. peer fell to almost the lowest in more than eight months, with the three-month 25-delta risk-reversal rate dropping to 1.01 percent on a closing basis. On Dec. 11 it closed at 0.99 percent, the lowest since April. The average this year is 1.25 percent.

Risk reversals measure the premium on options contracts to sell Canadian dollars versus buying U.S. contracts that do the opposite.

Inflation Rate

Canada’s consumer price index rose 0.9 percent in November from a year ago following a 0.7 percent rise the prior month, Statistics Canada said from Ottawa. The core rate, which excludes eight volatile products, slowed to 1.1 percent from the 1.2 percent pace in October. Both numbers trailed Bloomberg economist forecasts, which called for 1 percent total inflation and for core inflation to quicken to a 1.3 percent pace.

The central bank’s target band is 1 percent to 3 percent.

Exports and investment have been disappointing and inflation has been “lower than we can explain,” Poloz said in an interview with Bloomberg News on Dec. 17. The Bank of Canada’s forecast is that the economy won’t reach full output until around the end of 2015.

‘Notable Weakness’

The greenback gained as much as 0.7 percent versus the loonie after U.S. gross domestic product climbed at a 4.1 percent annualized rate, up from a previous estimate of 3.6 percent, Commerce Department figures showed. The median forecast of 72 economists surveyed by Bloomberg projected a 3.6 percent pace after 2.5 percent in the second quarter.

The growth data follow the Fed’s decision this week to cut by $10 billion its $85 billion of monthly bond purchases starting in January, and to taper “in further measured steps at future meetings” if the economy improves as forecast, according to a Federal Open Market Committee statement. It may trim buying by about $10 billion per gathering, Chairman Ben S. Bernanke said.

“It’s a notable weakness in the inflation report and strong U.S. GDP,” Greg T. Moore, a currency strategist at Toronto-Dominion Bank, said by phone from Toronto. “We’ve always expected the U.S. dollar to go higher, but now those moves will be advanced.”

Moore said Canada’s dollar may test C$1.08 “in the next few weeks” and the bank forecasts C$1.11 by year-end 2014, a level last reached in September 2009.

The median estimate of 38 economists in a Bloomberg survey is for the loonie to weaken to C$1.08 per dollar by the end of next year.

The Canadian dollar has fallen 3.6 percent this year against nine developed-nation currencies tracked by the Bloomberg Correlation-Weighted Index, while the U.S. dollar added 4.1 percent. The euro climbed 8.3 percent to lead gainers, and the yen paced decliners with a 15 percent drop.

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