The Canadian dollar’s rally since May could be described as relentless. We view the Bank of Canada (BOC) as currently the most hawkish developed market central bank, having hiked its overnight rate by 0.25 percentage points in two back-to-back meetings, bringing its policy rate to 1.00%.1
In recent media coverage, the BOC is showing signs that the strong appreciation of the Canadian dollar may lead the Bank to be more cautious. We believe the Canadian dollar is likely to pull back in the short term.
We expect the U.S. dollar to continue depreciating over the longer term. Our positive global growth view and outlook for global policy convergence toward the Federal Reserve’s (Fed) tighter stance will likely be a drag on the dollar against developed market currencies going forward. Capital flows into Europe, for example, have reinforced recent U.S. dollar weakness. The Chinese yuan has also appreciated sharply against the dollar, pointing to the global nature of this trend.
We maintain our forecast of further euro appreciation. In addition to support from the positive European growth backdrop, eurozone current accounts continue to run in surplus. Global inflation also remains subdued, which limits the risk of abrupt policy tightening among global central banks, including the Fed. This should continue to support the weak U.S. dollar trend.
We expect a mild retracement of the yuan in the weeks ahead after a sharp rally in early August. Longer term, the gradual pace of the yuan’s internationalization and capital account liberalization emphasized by President Xi in the National Financial Work Conference indicates continued capital controls and potential stability in the U.S. dollar/yuan exchange rate. Central bank officials have said they expect the yuan to trade around 6.5–6.6 per dollar by year-end. We expect it to trade in a range of 6.5–6.7 in a stable U.S. dollar environment and a range of 6.80–6.99 if the U.S. dollar strengthens sharply from here.
The yen is now back between ¥110–115 against the U.S. dollar, having temporarily breached the lower end of that range in August driven by concerns over North Korea.2 As we head toward the fourth quarter, we would expect the currency to remain range-bound unless geopolitical concerns escalate once again or the Fed is far more hawkish in its tightening signals.
British pound sterling:
We continue to have an optimistic long-term view on sterling, although it is likely to struggle in the near term due to disagreements among U.K. government officials on how to proceed with Brexit discussions. The country is divided, the government is divided, and an increasingly likely scenario is that the U.K. will end up with another election for Prime Minister. If this happens, we believe at least one of the candidates would favor walking away from Brexit discussions and resorting to World Trade Organization rules if necessary. This would potentially increase the chances of a hard Brexit and would be negative for sterling, in our view.
The Reserve Bank of Australia (RBA) appears satisfied to keep interest rates steady with consistent meeting statements month after month. Despite signs of an improving labor market, wage growth and inflation remain stubbornly low. Combined with concern over the robust housing market, we expect the RBA to remain on hold. The Australian dollar remains expensive, in our view, but our continued expectation for positive global growth keeps us neutral on the currency.