Canada's oil reserves helped buoy the country's currency during four years of financial-market turmoil.
Now, those oil supplies, Canada's biggest export, are becoming a liability for the Canadian dollar, investors said, even as crude prices globally have stayed high.
The crux of the issue: The boom in U.S. oil output has caused a glut in North America, driving down prices of Canadian crude. Sharply lower oil revenue is darkening the outlook for Canada's economy and worsening the country's trade deficit. The combination of these factors is weighing on the Canadian dollar, investors and analysts said.
Crude oil from Western Canada's oil sands, the country's main producing region, sells for about $65 a barrel, compared with $115 a barrel for oil traded on international markets and $97 in the U.S. Canadian oil's $50 discount to Brent, the benchmark for world oil prices, is nearly a record.
The recent performance of the Canadian dollar, also called the "loonie," stands in contrast to the performance of other currencies that tend to move in tandem with oil prices. The loonie is down 0.5% against the U.S. dollar this year and last week hit a five-month low, while Norway's krone and the Russian ruble are both up 1.8%. On Thursday, one U.S. dollar bought 0.9972 Canadian dollar, down from C$1.0012 late Wednesday.
"Canada has a petro currency," said John Hardy, head of foreign-exchange strategy at Saxo Capital Markets, a London unit of Saxo Bank A/S. "The fact that [Canadian] oil prices are off so much" will keep the currency weak. The discount widened last year amid a surge in U.S. oil production and a lack of pipelines to transport Canadian crude to higher-priced oil markets.
The decline in prices for Canadian oil was one reason the country's central bank on Jan. 23 cut its 2013 growth forecast, to 2% from 2.3%. The Bank of Canada estimates that low oil prices shaved about 0.4% off Canada's annualized growth of its gross domestic product in the second half of 2012.
Low oil prices also contributed to a widening trade deficit, which reached nearly C$2 billion in November, compared with a surplus of C$1.1 billion in the year-earlier period. A bigger trade deficit means fewer Canadian dollars are needed when companies repatriate revenue, pushing down the currency.
The Bank of Canada said economic conditions likely won't improve enough for a rise in interest rates until the second half of 2014. Many investors had bet on the Canadian dollar rising, in anticipation of higher interest rates this year.
"Fundamentally, the view has changed" on the Canadian dollar, said Blake Jespersen, managing director and head of foreign-exchange sales at BMO Capital Markets in Toronto. Mr. Jespersen said hedge funds and institutional investors have unwound those bets since last week's statement.
Still, Canada's benchmark interest rate, at 1%, is higher than most other major economies. Canada's central bank also has refrained from bond buying, unlike its counterparts in the U.S. and Japan. Those stimulus actions have flooded the market with dollars and yen and weakened those currencies.
And the Canadian dollar could get a boost if U.S. growth picks up, said Paresh Upadhyaya, director of currencies at Pioneer Investments in Boston, which has $204 billion in assets. He is betting the loonie will gain against the Australian and New Zealand dollars.
"When I look at what else is out there within the commodity bloc, Canada stands out," Mr. Upadhyaya said. "We have a very constructive view on the U.S. economy, and Canada will benefit from that."
But another key support for the loonie is fading just as prices on Canadian oil are plunging. Demand for Canada's triple-A-rated sovereign debt has lessened, as concerns about the euro zone and the fiscal debate in the U.S. have eased.
Foreign investment in Canadian bonds in November, the latest month for which data are available, was the lowest since June. Foreigners bought C$1.73 billion in government and corporate debt, down from C$15.49 billion the month before. Canada's 10-year bonds yielded above 2% this week for the first time since April. Bond yields move inversely to prices.
"The currency has been supported by bond-market buying for many years," said Clive Dennis, head of currencies at Schroders SDR.LN +1.86%PLC in London, which has £202.8 billion ($320.42 billion) in assets. "In a world where the currency should be getting a big commodities-boom benefit, it's been relying on financial flows, and that's a big sign that it's overvalued."
Mr. Dennis said he reduced his holdings of the loonie to zero about three months ago and expects it to weaken to C$1.10 against the U.S. dollar this year.