Currency traders bet Canada will follow Australia

Canada's next, eh mate.

International currency traders are treating Canada like Australia, strategists say, expecting the Bank of Canada to follow with its own interest rate hike, despite repeated comments from the Canadian central bank that rates will likely stay on hold until the middle of next year.

The perception drove the loonie to a one-year high this week, after the Australian central bank surprised markets by boosting rates for the first time since the financial crisis began.

The Reserve Bank of Australia, citing a strengthening economy, lifted its key rate by a quarter point to 3.25 per cent. The Bank of Canada's rate, by comparison, stands at just 0.25 per cent. The Canadian dollar touched a one-year high of 94.98 cents (U.S.) yesterday before closing at 94.13.

Many foreign-exchange players, who see the two commodity-heavy economies as similar, don't believe Bank of Canada officials will actually hold the line on rates until next summer, but will instead follow their mates Down Under. "Now that the Australians have raised rates ... the market is watching to see who will be next. And they're looking at Canada," said Jon Gencher, director of foreign-exchange sales for Bank of Montreal.

The expectation of higher rates, along with rising commodities, means parity is a possibility in the next three to six months, he said.

But most Canadian economists say that view is unfounded and expect the central bank to stick to its guns.

The bank declined to comment, though it has repeatedly said it expects rates to stay on hold. Bank of Canada Governor Mark Carney last week, however, appeared to hedge the bank's outlook by saying the low-rate pledge is "an expectation, not a promise."

Indeed, many currency experts aren't holding Mr. Carney to his word.

The economy is improving at a faster pace than anticipated, and that may force the central bank to change its tune, said Michael Woolfolk, a managing director of Bank of New York Mellon Corp.

"There's some suspicion in the market that the [Bank of Canada] view is getting long in the tooth and may not fit current economic or policy conditions," he said.

Mr. Woolfolk said the disconnect lies with the bank itself, which is on one hand saying interest rates will stay low, but on the other predicting the economy will jump 3 per cent next year.

"There's a curious anomaly between the Bank of Canada's monetary policy position and its stated economic outlook," he said.

Rates on hold at these levels suggest "we're in emergency mode still. But the emergency no longer exists," he added.

But some Canadian economists insist Canada is no Australia, and betting on a Canadian rate hike is "fundamentally unfounded," said Sébastien Lavoie, assistant chief economist at Laurentian Bank Securities.

"While the industrial structure is similar, Canada's overall economic picture is still highly different than Australia's one."

The chief reason is trade. Canada's main trading partner is the still-struggling United States, while Australia is benefiting from its exposure to China. And Australia escaped a recession, while Canadian GDP has yet to expand.

While Australia's move in itself doesn't guarantee a Canadian hike, commodity-based currencies will benefit, said Adam Boyton, senior currency strategist at Deutsche Bank in New York.

Watch out for Friday, though.

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