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Canadian dollar stronger than expected in July, near 6-month high of 94 cents US

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TORONTO - The recent strength of the Canadian dollar has been a surprise, given that many economists expected it to stay weak throughout much of the year.

But a combination of several factors has the dollar at least three cents higher than most forecasts for the year, with the loonie almost touching 94 cents US earlier this month and ending the week at 93.14.

"I think it is fair to say that (the dollar is) stronger than many had thought," Mark Chandler, head of foreign exchange strategy at RBC Dominion Securities Inc., said Friday.

Among the factors driving the loonie higher: a revised view of Canadian inflation trends, a weaker American economy and currency and a strong demand and prices for Canadian resources, particularly oil.

Chandler considers a weak U.S. currency as the leading factor for the loonie's relative strength but said it's also getting a boost from recent Bank of Canada comments that suggest there's now virtually no chance that short-term interest rates will fall.

"If you have your central bank, the Bank of Canada, saying 'We're really worried about low inflation and we're going to have to cut rates' — that would tend to weaken the currency," Chandler said Friday.

"And if they step away from that, you take away that source of currency weakness."

BMO Capital Markets economist Sal Guatieri said that Canada has actually had one of the strongest currencies since the spring, fuelled by foreign demand for Canada's relatively high short-term interest rates compared with those available in the United States, Europe and Japan.

"A lot of global capital is seeking higher rates of return, so we're seeing some of that money parked in the Canadian money market," Guatieri said

But Guatieri said BMO is still expecting the Canadian dollar's value will drop closer to 87 cents US by next year, a stance that many other economists took at the end of last year in their 2014 forecasts.

"There are many other factors that suggest that the Canadian dollar should not be at 93 cents right now. In particular, the ongoing trade deficit," Guatieri said.

"Outside of energy, the trade balance is still shrinking, still declining. For example, our trade balance in automobiles is plunging off a cliff and that is a function, partly, of an overvalued Canadian dollar."

Based on research that BMO did into retail-level pricing, he said, a Canadian dollar needs to be worth less than 90 cents US to offset some of the other factors that make goods more expensive here than in the United States.

"It's only when the Canadian dollar is closer to the mid-80s that the price differential is equalized in the two countries," Guatieri said.

He said it's a different picture in energy commodities, particularly because of "elevated oil prices and strong U.S. demand for our oil (and) the fact that we've had much better success getting our oil down to the U.S. Gulf Coast refineries in the past six months."

- Follow @DavidPaddon on Twitter.

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