Analysis - Blocked foreign takeover adds to C$'s struggles

TORONTO Mon Oct 22, 2012 7:55pm BST

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TORONTO (Reuters) - Canada's dollar will feel longer-term pain from the government's shock decision to block a Malaysian bid to take over Progress Energy Resources Corp PRQ.TO, which suggests the country may be less receptive to foreign capital in the future.

The currency hit a two-month low after the news, which comes a week after the head of Canada's central bank omitted a key hawkish line from a speech, spurring many traders to sell the Canadian dollar.

Foreign takeover bids for Canadian resource companies helped drive the currency to a modern-day high above $1.10 (70 pence) in 2007.

Strategists said that while a drop in merger and acquisition activity since then has reduced their impact, hints that mining and energy companies are off limits to some buyers will weigh on the Canadian dollar's prospects.

"It's not just the actual impact of the dollars, it's the whole psychology behind the sentiment, if people believe the story then it has a bigger impact," said Camilla Sutton, chief currency strategist at Scotiabank in Toronto, who nevertheless is projecting the Canadian dollar to appreciate by year-end.

FEAR FOR NEXEN DEAL

Ottawa said late on Friday it would not accept Malaysian state oil firm Petronas' existing C$5.17 billion bid for gas producer Progress Energy Resources Corp PRQ.TO, in turn darkening the clouds around CNOOC (0883.HK) of China's C$15.1 billion interest in oil producer Nexen Inc NXY.TO.

"Clearly, having one knockback heightens expectations of a second," said Jeremy Stretch, head of foreign exchange strategy at CIBC World Markets in London. "There is a realistic risk that that deal could fall in the same direction."

The Canadian dollar depreciated to C$0.9964 to the U.S. dollar or $1.0036 on Monday, its weakest level since August 10.

It also slid against other major currencies, reaching its weakest in almost two months against the Australian dollar. The Canadian and Australian dollars often trade in the same direction because both have economies heavily dependent on natural resource exports.

"Canada on the one hand says it needs to have more investment in its commodities, especially its shale and oil industries, then when a company tries to (invest), it looks like they might send them away," said Marc Chandler, the global head of currency strategy at Brown Brothers Harriman in New York.

"Some people will say there is protectionism in Canada."

He said the block likely does not necessarily signal the government's intention towards the larger CNOOC-Nexen deal, but "that's what investors are afraid of."

Meanwhile, the sudden reversal in bullish sentiment has trapped a significant number of speculative traders in long positions on the Canadian dollar, he said. This means they may look to exit them on any near-term strength in the currency.

Chandler sees the Canadian dollar weakening to equal value with the U.S. dollar in the near term.

FOCUS SHIFTS TO BANK OF CANADA

Some strategists, however, were loath to draw too broad a conclusion from one nixed deal.

"The only clear implication you can draw is that it is a bit harder for state-run enterprises to pick up what might be considered to be fairly important or strategic assets in Canada," said Shaun Osborne, chief currency strategist at TD Securities in Toronto.

The currency actually appreciated in the months after Ottawa blocked a major resource deal - BHP Billiton's $39 billion bid for Potash Corp - in late 2010. At that time, rising commodity prices offset the impact of the blocked bid.

This time around, the fact other major economies are printing money to boost growth while Canada holds interest rates steady could offset any sharp weakness.

While the Progress Energy news hit the Canadian dollar on Monday, foreign exchange traders said they were more focused on the outcome of the Bank of Canada's policy-setting meeting on Tuesday.

A Reuters poll released on Thursday suggested the central bank will postpone interest rate hikes until the fourth quarter of next year and will likely water down, rather than eliminate, its hawkish language. <CA/POLL>

Since Governor Mark Carney's speech last Monday, the Canadian dollar has weakened by more than 1 percent. But despite increasing expectations that the central bank will drop its tightening bias, the relative outlook for Canada could cap further weakness.

"Even a softer or a neutral tone from the Bank of Canada juxtaposed against the Fed ... is still Canadian dollar positive," Scotiabank's Sutton said, referring to much more aggressive monetary easing from the U.S. central bank.

She noted that the greenback also faces a tumultuous time ahead with the U.S. presidential election and a looming "fiscal cliff" of automatic tax hikes and spending cuts to navigate.

(Editing by Jeffrey Hodgson and Chizu Nomiyama)