Reuters | December 7, 2010

Canada's dollar will grind higher against the greenback in 2011 and 2012, boosted by demand for commodities and interest rates higher than those found in the United States, Scotiabank predicted.

The S&P/TSX composite index is also likely to rise more than 5 percent from current levels by the end of next year as the economy recovers further, the bank said in an economic and market outlook.

Camilla Sutton, chief currency strategist at the bank's Scotia Capital arm, said she expects the Canadian currency to end 2010 at parity with the U.S. dollar.  Just over a year from now Sutton expects one Canadian dollar to be worth $1.04 US. She forecast the currency will firm further to $1.06 by the end of 2012.  "Our forecast for Canada is that we are essentially at parity and we move sustainably through parity in 2011, and remain there in 2012," said Sutton.  Such a move would not be unprecedented. In November 2007, the currency rose to a modern day high around $1.10.

In addition to commodity exposure and rate differentials, Sutton thinks Canada's stronger fiscal stance and a weak greenback will contribute to the gains.  The currency weakened on Tuesday after the Bank of Canada held its key interest rate steady, as expected, and issued a statement widely seen as dovish. The central bank set the stage for rates to pause at 1 percent for some time by emphasizing its concern over weaker exports and the risks posed by Europe's debt woes.

All 44 forecasters surveyed by Reuters last week had predicted no change in rates, but markets are divided on the timing of the first increase in 2011.  Warren Jestin, chief economist of Scotiabank, predicted the central bank will hike rates in the fourth quarter of 2011. However, if the Canadian dollar bursts higher in a short period -- rising to anywhere between $1.04 and $1.06 -- he sees a slight risk the central bank could surprise with a rate cut.  "We don't put that as a high-odds bet, but with the currency volatility we've seen over the last couple of years it is in the realm of possibility," he said.

Vincent Delisle, director of portfolio strategy at Scotia Capital, said Canada's main stock index is headed for 14,000 by the end of 2011, lifted in part by steady U.S. economic growth.

He favours cyclical over defensive stocks in 2011. And in an environment of low rates, he expects securities offering high yields and dividends to "reward investors once again."