Pound-to-Canadian Dollar Rate Week Ahead Forecast: Downside Risks Abound as Key Data Looms

- GBP/CAD technical outlook bearish ahead of key data.

- Simultaneous falls in USD/CAD, GBP/USD seen this week.

- That means downside risks for GBP/CAD rate up ahead.

- Tuesday's UK jobs data, Friday PMIs key to GBP outlook.

- CPI data, BoC decision and retail sales in focus for CAD.

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The Pound starts the new week softer against its Canadian counterpart, with the GBP/CAD exchange rate edging lower as the pair's ongoing downtrend extends.

Sterling closed 0.29% lower against the Canadian Dollar last week after softening inflation and dire retail sales data out of the UK encouraged markets to increase expectations for a January 30 interest rate cut from the Bank of England (BoE). 

The Pound has failed to regain the upward momentum it had in mid-December despite a New Year attempt to return to earlier highs, and has carved out a series of lower highs and lower-lows on the charts this month that advocate for further declines:

Above: Pound-to-Canadian Dollar rate shown at 4-hour intervals.

Sterling's price action thus far in the New Year has left it at risk of a continued drift lower in the coming days, a risk that is enhanced by charts that suggest the USD/CAD and GBP/USD rates may each see further declines this week.

"After the sharp USD rebound last week, the lack of follow-through demand for the USD suggests the rebound from the 1.2950 zone has stalled. Gains through 1.3105/10 are needed to boost the USD from here. Key support is 1.3025," says Juan Manuel Herrera, a strategist at Scotiabank, in a Friday research note. 

Above: USD/CAD rate shown at 4-hour intervals.

The Pound-to-Canadian Dollar rate always closely matches the sum of GBP/USD divided over CAD/USD so when the Pound is expected to decline relative to the U.S. Dollar at the same time as the Canadian Dollar is seen getting the better of its larger North American rival, then Sterling can be expected to fall relative to the Loonie.

And Sterling is at risk of ceding further ground to the U.S. Dollar over the coming days, according to technical analysis from Commerzbank, while Scotiabank is looking for a USD/CAD retreat in the absence of a clear break above 1.3105.

However, the Pound-to-Canadian-Dollar rate may not stray too far from current levels any time soon because it's forecast to end the quarter at 1.70.

Scotiabank expects the exchange rate to trade close to 1.70 at the end of each quarter in 2020, although that doesn't mean it won't deviate from there inbetween quarters. Canadian banking co-operative Desjardins also has a similar outlook for the exchange rate.

Above: Pound-to-Canadian Dollar rate shown at daily intervals.

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Pound Sterling: What to Watch 

The Pound was the worst performing major currency last week although it still faces a plethora of risks that have scope to cause volatility in the coming days.

Tuesday marks the release of unemployment and wage growth figures for December, which have been elevated in importance by the dire messages coming from other figures released over the last fortnight.  

“Looking ahead, we are fast approaching two big events: The Bank of England decision on interest rates on 30th January preceding the deadline for Brexit the very next day,” says Lee McDarby, managing director of corporate foreign exchange and international payments at Moneycorp. “Sterling continues to be stable, though this could be the calm before the storm. More information on the Bank of England’s decision this coming week could weaken the pound.”

Consensus is looking for the unemployment rate to have held steady at a multi-decade low of 3.8% in December and for wages to have grown by an annualised 3.1%, down from 3.2% in November.

The data is out at 09:30 Tuesday while IHS Markit PMI surveys are due at the same time Friday. Markets are looking for the globally as well as domestically troubled manufacturing sector to have undergone a stabilisation.

The manufacturing PMI is seen rising from 47.5 to 48.8 but remaining below the 50 level that separates industry expansion from contraction. Meanwhile the more important services PMI is seen rising from 50.0 to 51.1 this month. 

“A stream of disappointing UK data has confirmed the MPC's concerns and sharply increased the odds of a January rate cut. Both November UK labour data and January PMIs will be crucial factors to watch next week. A downside surprise or signs that the data is not improving would likely cement market expectations of a cut,” says Chris Turner, head of FX strategy at ING. 

Inflation and retail sales data out last week have prompted the market to go further in pricing-in a January 30 interest rate cut from the Bank of England and in the process, undermined appetite for the British currency.  Retail sales revealed the economy hasn't seen any boost from the so-called Black Friday sales promotions, which it typically does, adding to mounting evidence of a final quarter economic contraction.

Inflation of 1.3% is well below the BoE's target of 2% and growth was just 0.6% in the 12 months to December, leaving it substantially below the economy’s estimated 1.25% inflation-producing rate of expansion. This could mean a rate cut is inevitable although Tuesday’s jobs data, Friday’s PMI surveys and the January 29 Autumn forecast statement could yet persuade the Monetary Policy Committee into leaving Bank Rate unchanged at 0.75% for a few months more while they observe the development of the economy. 

Pricing in the overnight-index-swap market had fallen to imply on Friday, a month-end Bank Rate of 0.55%, below the current 0.75% but still a fraction above the next level down of 0.50%. And the implied Bank Rate for December 23, the final interest rate decision of the year, had fallen to 0.40%.

“This suggests that the downside to sterling may be limited. Indeed, disappointing retail sales for December sparked only a muted reaction in the currency on Friday. If anything, the risks are skewed to more pronounced GBP upside (than downside) next week, as a possible rebound in PMIs would reverse expectations of monetary easing. Hence, our asymmetric GBP/USD range with an upside skew for next week (1.2950-1.3200),” says ING’s Turner.

Current market expectations mean there’s upside as well as downside risks to Pound Sterling in the coming weeks because, if the BoE does cut this month then there’s no telling what investors might price-in for later in 2020.

And if the BoE holds rates steady and indicates it might wait a while before cutting, implied levels for subsequent months may rise. However, ING says that in such circumstances, rallies in the Pound would also be limited because markets might still fear a rate cut at a later date. 

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The Canadian Dollar: What to Watch

The Canadian Dollar was the third best performing major currency last week but will in the days ahead be impacted not only inflation and retail sales data for December, but also the latest Bank of Canada (BoC) interest rate decision. 

Consensus is looking for inflation to have remained at 2.2% in December, above the 2% target of the BoC, and for the country's various measures of core inflation to continue to average the target threshold. The data is out at 13:30 Wednesday and any upside surprises would likely be supportive of the Canadian Dollar because they might complicate the BoC's task of justifying any interest rate cuts that may or may not be announced in the months ahead.

However, and arguably, it'll be rhetoric from the BoC itself as well as Friday's December retail sales report that most impact the market's appetite for the Canadian currency going forward. The BoC's 15:00 interest rate decision and statement on Wednesday will provide the market with fresh clues on the sustainability of Canada's 1.75% cash rate, which has made Canadian government bonds the highest yielding in the developed world. 

"It would be reasonable to expect a dovish tone from Governing Council next week. Our current tracking points to growth having slowed to an annualized 0.7% pace in Q4/19, below the BoC’s already sub-trend 1.3% forecast," says Nathan Janzen, a senior economist at RBC Capital Markets. 

Friday's 13:30 retail sales figures will provide insight into the likely pace of GDP growth in December, which is the final piece of a so-far ugly fourth-quarter puzzle. The figures are expected to show Canadian household store spending rising by 0.5% in December, which would partially reverse a -1.2% contraction from the prior month. However, the core number will garner more attention from the market and there's currently no consensus available for that. 

Canada's economy, like many others, is widely believed to have slowed in the final quarter of 2019 after having outperformed its developed world rivals through the earlier quarters of the year. That outperformance and above-target inflation have enabled the BoC to leave its cash rate unchanged at 1.75% while making Canadian bond yields the most attractive for investors when stood next to those of other major economies but a global interest rate cutting cycle has prompted questions about their sustainability. 

"Leveraged funds are now running the largest short CAD position since the middle of last year when USD/CAD last attempted unsuccessfully to break below the 1.3000-level. It was then followed by a rebound back up towards 1.3400....The search for yield has seen the CAD diverge from the cyclical performance of the Canadian economy," says Fritz Louw, a currency analyst at MUFG. "The recent run of disappointing economic data releases from Canada suggests that the rate market may have gone too far."

Canada's jobs market creaked in November but a strong December rebound has since seen investors do away with fleeting wagers that had suggested the BoC might actually cut its cash rate over the coming months. Pricing in the overnight-index-swap market has seen the implied cash rate for Wednesday rise from 1.65% in early October to 1.75% on Friday. Meanwhile, the implied rate for June 03 has risen from 1.56% to 1.66%.

Both of those implied rates are below the current 1.75% cash rate but still a long way above the next level down of 1.5%.

"The probability of a rate cut by the June policy meeting has fallen to only around a “1 in 4” shot compared to almost fully priced in only a couple of months ago. The last time the Canadian economy was this weak was back in 2015/16 when 50bps of rate cuts were delivered in response. It leaves the CAD vulnerable to the downside if the BoC strikes a more cautious tone at next week’s policy meeting," Louw says. 

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