The Pound-to-Canadian Dollar Week Ahead: Finding Support On Charts as BoC Outlook Questioned

- GBP/CAD finds support after overcoming key chart level. 

- GBP supported by 40-day moving-average as CAD wobbles.

- Fundamental GBP downside also limited, upside is building.

- After market almost fully prices a BoE rate cut for Thursday. 

- BoE may eschew a Jan cut just as market eyes a BoC move.

- Market to watch CA like a hawk, seeking signs of weakness.

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- GBP/CAD Spot rate: 1.6968, -0.35% on Friday

- Indicative bank rates for transfers: 1.6611-1.6731

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The Pound closed Friday's session having become the second best performing major currency of the week although there could be further gains in store for the coming days if newfound support on the charts holds and the Bank of England (BoE) eschews a Thursday interest rate cut.

Sterling was one of only two major currencies to get the better of the U.S. Dollar last week after economic data led markets to rethink their expectations of Thursday's interest rate decision from the BoE, although it weakened in line with investor appetites for risk on Friday.

Meanwhile, the Loonie was the third worst performer after the sustainability of an alluring 1.75% Bank of Canada (BoC) cash rate was called into question, although it benefited from yield-seeking among investors ahead of the weekend.

Market pricing still implies that a BoE rate cut is likely, albeit to a lesser extent than previously, so Thursday's decision could well be a source of gains for Sterling. But upside potential doesn't come only from the fundamental side because the charts are also offering support to the Pound following the Canadian sell-off seen in the aftermath of Wednesday's BoC decision. 

The Pound rose and closed above its 40-day moving-average last Wednesday and has since found support on the former-resistance level that was tipped by Scotiabank as key to the outlook.

And crucially, analysts are increasingly looking for the USD/CAD rate to rise at the same time as expectations of a stabilisation in GBP/USD are mounting. That could mean a higher Pound-Canadian Dollar rate ahead because GBP/CAD always closely matches the sum of GBP/USD over CAD/USD. 

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

"We remain long USD/CAD  via options with strengthened conviction after this week’s dovish BoC meeting. The Bank struck a meaningfully more cautious take on the economic outlook following disappointing Q4 data, while the external risk environment has deteriorated from the coronavirus outbreak," says Jordan Rochester, a strategist at Nomura. "From here, we expect US-CA rates spreads to tighten further (even after the adjustment, markets are only assigning a ~50% chance of a cut by the April meeting).This trend could further reinforce an already challenging backdrop for flows into Canadian assets."

Rochester and the Nomura FX research team are forecasting an increase to 1.32 by the USD/CAD rate before the end of March although they said last week that risks are now very much tilted toward an overshoot of that level after the BoC put markets on alert for a possible interest rate cut in the months ahead. Rochester says the exchange rate could test 1.33 in the coming weeks.

Given the charts as well as fundamentals are pointing the GBP/USD rate to the upside for the days ahead, any further increase in the USD/CAD rate this week could help the Pound-to-Canadian-Dollar rate extend its recent run of gains.  

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

Pound Sterling: What to Watch 

The Pound was the second best performing currency for the week by the Friday close but could go on to extend gains over the coming days if the Bank of England refrains from cutting interest rates Thursday. 

Sterling was soft last week before strengthening from Tuesday after December's jobs and wages data surprised on the upside, giving investors cause to pare back some of their earlier bearish bets on the British currency ahead of this Thursday's eagerly-awaited decision from the BoE. That move was aided Friday by IHS Markit PMI surveys that pointed to a stronger-than-expected uptick in services and manufacturing activity for January.

Brexit Day on Friday, 31 January will doubtlessly garner many column inches in the week ahead although the date will mark an EU exit that wholly technical and legalistic in nature so will matter little for the immediate prospects of Pound Sterling. Price action in the UK currency will instead be determined by speculation ahead of Thursday's interest rate decision from the BoE.

The consensus among economists and analysts is for the Bank of England to leave Bank Rate unchanged at 0.75% at 12:00 Thursday although that view is in now way reflected by pricing in the financial markets, with pricing in the overnight-index-swap (OIS) market implying on Friday morning a January 30 Bank Rate of just 0.55%. Market pricing implies around an 80% probability of a rate cut this week but economists say it won't happen and only one can be right.

"Hard UK macro data such as retail sales and GDP have made it clear that the economy had a dismal fourth quarter, in large part due to political uncertainty from the general election and the risk of a no-deal Brexit," says Ranko Berich, head of market analysis at Monex Europe. "The MPC must balance the significant slowdown in growth seen in Q4 against the probable recovery that currently appears to be happening."

BoE Governor Mark Carney and various other Monetary Policy Committee members said earlier this month they'd vote for a rate cut Thursday if they did not see signs of improvement in the New Year economy before then. So Friday's PMI data could excuse the BoE for eschewing a rate cut this week but the surveys have often proven to be unreliable indicators during times of political uncertainty and the bank itself was bitten for having put faith in them in the immediate aftermath of the referendum.

Furthermore, Thursday's meeting marks the final outing of Governor Mark Carney as chair of the MPC because he's set to depart the bank on March 16, and so his last opportunity to engineer a rethink of the MPC's long-held contention that interest rates will need to rise from current levels over the coming years in order to keep inflation in check. That idea explains why the BoE has left bank rate unchanged since August 2018 despite most other comparable central banks having cut rates.

"Our economists expect the bank to err on the side of caution and to remain on hold," says Chris Turner, head of FX strategy at ING. "The scale of the GBP upside may not be pronounced as the uncertainty about the UK economic data and the tightest voting margin behind the BoE decision not to cut rates suggest that the market will continue pricing a non-negligible probability of a cut in coming months. So the market will postpone the expectations of the cut rather than fully reverse it."

Carney and colleagues have argued higher rates will be necessary because the Brexit vote has reduced the UK's growth 'potential' and left the economy more susceptible to inflation, despite the consumer price index having been in decline since November 2017 when it was recorded at 3.1%. Inflation was just 1.3% in December, far below the BoE's 2% target, while the economy is growing beneath its 'potential' or inflation-producing rate of expansion.

Given current market pricing any rate cut may deliver only limited downside to Sterling unless the BoE hints that further cuts could follow in the coming months. And given the bank may yet decide to eschew a cut, the potential upside could be greater than the downside this week. 

However, international factors will also be in the mix and could see other currencies advance on Sterling. Notably, Eurozone growth and inflation figures as well as the January Federal Reserve (Fed) rate decision. 

Pound Sterling Live previously reported that there would be an autumn forecast statement on Wednesday 29, January. This resulted in part from an error made by a third party data provider. The budget will not be released until March 11.

The Canadian Dollar: What to Watch 

The Canadian Dollar was the third worst performing major currency last week after the Bank of Canada cast cloud of uncertainty over the outlook for interest rates in the North American economy, an uncertainty that could define trading in the Loonie for a few weeks yet. 

Canada's Dollar finished the week strong amid healthy demand for anything that offers a modicum of yield but the sustainability of current yields could increasingly be questioned in the weeks ahead after the Bank of Canada hinted that it could soon cut what is one of the highest cash rates among major currencies if it doesn't see signs of an economic rebound in the coming months. 

"We’re still expecting a relatively sluggish Canadian economy in 2020. Should job growth continue to look muted, a now-stand-pat BoC could be pushed into action to support the non-energy parts of the economy, rather than being preoccupied with restraining debt accumulation. A rate cut would get the ball rolling on currency depreciation, seeing USD/CAD reach 1.36 by year-end," warns Avery Shenfeld, chief economist at CIBC Capital Markets. 

Canada's 1.75% cash rate is matched only by that of the Fed among major developed economies and the fact it was left unchanged throughout 2019, as other central banks cut their rates, played a key role in making the Loonie the best performing major currency of the year. But it's now under threat. 

The BoC said last Wednesday that consumers are one of Canada's main sources of economic resilience and hinted that if spending doesn't pick up sufficiently in the months ahead, then it could then feel compelled to cut rates. That was just days before November's retail sales numbers left the currency market feeling underwhelmed.

Canada's central bank said it will "be watching closely to see if the recent slowdown in growth is more persistent than forecast," before flagging consumer spending, the housing market and business investment all as things it'll be scrutinising. The BoC has effectively put markets on notice. 

"The door has been opened for a rate cut if the slowdown proves more persistent. It should keep CAD under selling pressure in the near-term," says Lee Hardman, a currency analyst at MUFG.

This means Thursday's speech from BoC Deputy Governor Paul Beudry and Friday's GDP data for November will be watched closely, although some have questioned the merits of reading too much into the growth number given it's related only to the final quarter of 2019 and the BoC is already well aware the economy weakened into year-end and likely underperformed its forecasts. 

With economic data covering the New Year period not expected to be released until mid-to-late February, uncertainty about the performance of Canada's economy and the outlook for its interest rates could be set to dominate trading of the Canadian Dollar in the weeks ahead. And given the currency had traded near to a two-year high as recently as last week, the Loonie may well remain biased toward the downside for a while yet. 

"Canadian economic data is volatile at the best of times. We saw similar softness in economic data over the winter a year ago only to see a bounce back in the spring," says Nathan Janzen, a senior economist at RBC Capital Markets. "We continue to think that Canadian economic growth data will bounce-back somewhat over the first half of 2020 – but not significantly enough to keep the BoC from cutting rates in April."

That could support the Pound-to-Canadian-Dollar rate although much also depends on developments in the UK economy, not to mention the decisions of the Bank of England because any rate cuts in the UK would negate the effect of a BoC rate cut on the UK-CA interest rate differential.