Pound-to-Canadian Dollar Rate Week Ahead: Upside Bias Intact with BoC Outlook in Focus

- GBP/CAD retains upside bias as data looms for both currencies.

- GBP/CAD supported above 1.71, with upside near to 1.75 level.

- But relative GBP/USD and USD/CAD price action key to outlook.

- GBP faces jobs, inflation, retail sales and PMI data in week ahead.

- CAD sees inflation and retail sales figures put spotlight on BoC.

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- GBP/CAD Spot rate: 1.7289, up 0.82% last week.

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The Pound-to-Canadian Dollar rate retains an upside technical bias heading into a week that's set to bring the market's focus back onto the outlook for interest rates on each side of the exchange rate equation, with downside risks for both. 

Pound Sterling was the best performing major currency last week, rising almost a full percentage point against the Canadian Dollar, after the appointment of Conservative Party MP Rishi Sunak as Chancellor lifted expectations for growth, inflation, interest rates and the currency this year.

Meanwhile, Canada's Dollar ended the week higher against safe-havens like the Yen and Franc as well as the lower-yielding Euro and its closely tied counterparts like the Swedish Krona. But the loonie ceded ground to other commodity currencies like the Aussie and New Zealand Dollars. 

Price action has seen the Pound-to-Canadian Dollar rate retain its upward bias, with a long-running technical uptrend still intact but it will be economic fundamentals that determine if that remains the case come Friday's close. 

Above: Pound-to-Canadian Dollar rate shown at 4-hour intervals alongside 2-year GB bond yield (orange line, left axis).

"We think the low 1.71 zone (1.7115/30) now figures as key support," writes Juan Manuel Herrera, a strategist at Scotiabank, in a research note early last week. "A relapse back under 1.7115 would trigger renewed weakness and point to a retest of the low 1.62 zone." 

Canada's Dollar benefited last week from a steady increase in oil prices as well as a modest uptick in short-term Canadian government bond yields evidence by the gentle decline in the USD/CAD rate, which is a key driver of the GBP/CAD rate, from Tuesday onward. 

However, the oil and yield-induced loss of 0.43% in the USD/CAD rate was not enough to offset the 1.26% gain seen in the GBP/USD rate, which explains the rise in GBP/CAD over the course of the week. The Pound-to-Canadian Dollar rate is simply the sum of GBP/USD over CAD/USD. 

Above: Pound-to-Canadian Dollar rate shown at daily intervals alongside 2-year GB bond yield (orange line, left axis).

"Intraday pressure on USDCAD is tilted to the downside from a technical point of view and spot is fractions away from sealing a more decisive swing lower; a push under last week’s 1.3233 low today will form a bearish weekly reversal. The USD is, however, finding steady support," Herrera said Friday. 

This week's outcome for the USD/CAD rate, not to mention GBP/USD, will be key in determining the next steps in the Pound-to-Canadian Dollar rate although the rub for the Loonie is that USD/CAD has continued to find support at 1.3240.

1.3240 is a key level according to Scotiabank, which must be broken through if more USD/CAD losses are to be assured.

For the Loonie there are only two pathways toward higher levels against Pound Sterling and one of those requires USD/CAD to break below 1.3240 while the other needs last week's GBP/USD rally to come apart at the seams. Either, both or neither could happen in the week ahead. 

Above: USD/CAD rate shown at 4-hour intervals alongside GBP/USD rate (red line, left axis).

Pound Sterling: What to Watch

The Pound was last week's best performing major currency but sustaining that performance through the week ahead will be a tall order given that a raft of key economic figures are set to put the Bank of England back in the spotlight. 

Pound Sterling was buoyed last week when markets saw the appointment of Conservative Party MP Rishi Sunak as Chancellor heralding greater agreement, if-not consensus between the PM's office and treasury when it comes to joint decisions over government spending plans.

The appointment has gotten investors as well as Pound Sterling banking on a larger fiscal stimulus being delivered in the March 11 budget than was previously imagined, which is expected to lift economic growth, inflation, interest rates and the Pound in the months and years ahead.

But some in the market say that Sterling and its newfound backers have gotten ahead of themselves.

"While we would expect some fiscal stimulus, it’s unlikely the government will want to use all of its ammunition with the next election so far off. In turn, markets may receive little indication to endorse such expectation next week which may fuel a correction in GBP," says Chris Turner, head of FX strategy at ING. 

Pound Sterling narrowly escaped an interest rate cut in January after the BoE opted to wait and observe the performance of the economy in January and as a result, markets have reduced the assumed probability of a rate cut coming in the first half of 2020, but that assumption will be tested this week. 

Tuesday at 09:30 will bring January jobs data and the Pound would be unlikely to take kindly to any perceived deterioration in the outlook for employment. Consensus is looking for the unemployment rate to remain at 3.8% but for the annualised pace of wage growth to have dipped from 3.2% to 3.1%.

"Our short term indicators continue to point to some upside pressure for unemployment, which we think could crystalise by summer," says Sanjay Raja, an economist at Deutsche Bank. "We expect inflation to track below the Bank's forecasts through Q1, raising more concerns for the MPC as we head into Spring...we expect retail sales (ex-auto) to rise by a pretty sizeable amount (1.2% m-o-m), which would mark the largest single month increase in nine."

Any increase in unemployment, or meaningful decline in wage growth, would undermine the outlook for inflation, interest rates and the Pound.

And inflation already fell sharply at year-end, from 1.7% to 1.3%, leaving it even further below the 2% target of the BoE. 

Wednesday at 09:30 will see January's consumer price index released and markets are looking for the inflation rate to have returned to November's 1.7% level with the more important core inflation rate also seen retracing at least some of its earlier decline. Core inflation is seen rising from 1.4% to 1.5%. 

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

"The flurry of data releases will further reduce expectations of an interest rate cut this year by showing that the labour market stayed healthy in December (due Tuesday), inflation rebounded in January (Wednesday), retail sales bounced back in January (Thursday) and the upturn in the activity PMIs continued," says Paul Dales, chief UK economist at Capital Economics. 

Pricing in the overnight-index-swap market implied on Friday an August 06 Bank Rate of 0.59%, which is below the current 0.75% but still meaningfully above the next level down of 0.50%. In other words, there's both upside and downside risks for Sterling from any changes in market expectations for interest rates. 

Those expectations will evolve in response to the jobs and inflation data but retail sales figures for the month of January and the IHS Markit flash PMI surveys of the manufacturing and services sectors for February will arguably say more about the outlook for inflation and interest rates. 

"We look for total retail sales to rise by 0.3% over the month and for the ex-fuel measure to increase by 0.4%," says Philip Shaw, chief economist at Investec. "We are pencilling in a half point drop in the UK manufacturing PMI to 49.5. For the UK services PMI we look for the PMI to stand at 53.4."

Markets are looking for 0.7% gain in UK retail sales to have reversed a 0.6% decline from December when the January data is released at 09:30 Thursday.

Those figures will be important to the BoE outlook because they'll speak volumes about the New Year state of the consumer, which has been a linchpin of the economy in recent years. 

Even more important are the IHS Markit PMI surveys of the manufacturing and services sectors due out at 09:30 on Friday because they'll provide a number of insights about the current state of the economy and the outlook for it. 

"Should a steady or extended bounce in the PMI not be validated, the market may be inclined to return to pricing modest easing back into the OIS curve in H1-2020, leaving GBP on the defensive," warns Mazen Issa, a strategist at TD Securities. 

PMI surveys will reveal the extent to which the outlook has been burnished by the UK's orderly exit from the EU into a transition period on January 31 and the 'phase one deal' between the U.S. and China, which has at least temporarily ended the trade war between the world's two largest economies.

And they'll also provide clues about the impact the coronavirus might have on two of the UK's most important business sectors over the coming months. 

"A key question for the upcoming ‘flash’ February PMI is whether it will paint a picture of an economy experiencing some renewed downside influences as a result of the new coronavirus," Shaw says. "There remains significant uncertainty over how big and how persistent a blow the global economy will be dealt as a result of the coronavirus (Covid-19). We suspect that some of these concerns will start to spill over into sentiment, particularly for manufacturers."

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The Canadian Dollar: What to Watch

Canada's Dollar crept higher alongside bond yields and international oil prices last week but economic data and the outlook for Bank of Canada (BoC) interest rates will return to the driving seat over the coming days. 

The week ahead will bring with it a raft of Canadian economic figures but Wednesday's inflation and Friday's retail sales data are the big ones that will matter most to the Loonie and rate setters at the BoC.

Markets are looking for Canadian inflation to have risen to from 2.2% to 2.4% in January off the back of a monthly increase of 0.3%. However, the 'common core' measure of inflation is expected to have remained steady at 2%, bang in line with the 2% target of the BoC.

"Inflation is set to print its fastest reading since 2018, but that’s not an indication of growing price pressures as its largely the result of weak prices a year ago. Indeed, recent momentum suggests underlying prices aren’t actually growing all that fast," says Royce Mendes at CIBC Capital Markets. "Underlying inflation is also set to look softer according to the Bank of Canada’s core common component measure, which our model suggests will tick down to 1.9%."

Above: CAD/USD rate shown at daily intervals alongside 2-year Canadian government bond yield (red line, left axis).

Inflation data matters greatly to currencies because it's the prospects of consumer price pressures over a roughly two-year period that dictates the outlook for interest rates, although inflation is itself sensitive to many things including household demand within an economy. This, combined with recent BoC guidance, means Friday's retail sales numbers will be especially important for the Canadian Dollar's performance this week and in the weeks ahead. 

The Bank of Canada acknowledged in January that the economy has been softer than its recent forecasts implied and indicated that any further underperformance of those projections will be met with an interest rate cut over the coming months, although markets have either grown bullish on the Canadian economic outlook or simply calling bluff to BoC Governor Stephen Poloz. The current cash rate is 1.75%.

"Weaker activity in Q4 19 saw the central bank soften its neutral stance. Still, it does not seem particularly close to cutting rates. Investors seem to favor a cut near mid-year at Governor Poloz's last meeting," says Marc Chandler, a managing director at Bannockburn Global Forex. "The  CAD1.3400-CAD1.3450 area has blocked stronger US dollar gains over the past six months.  The Canadian dollar may be quick to recover when the fear and anxiety breaks."

Above: CAD/USD rate shown at daily intervals alongside WTI crude oil futures price (red line, left axis).

Pricing in the overnight-index-swap market implied on Friday a cash rate of 1.64% following the April 15 policy decision, which implies just less than a 50% probability of a rate cut being announced by then. Such expectation means there's both upside and downside risks to the Canadian Dollar from economic data released in the months leading up to the meeting. 

The BoC said in January it will be paying particular attention to "developments in consumer spending, the housing market, and business investment," as it determines its next interest rate decisions and for that reason, Friday's retail sales figures are arguably the most important release of the week for the Canadian Dollar. Consensus is looking for sales to have risen 0.1%  in December after a 0.9% November gain with core retail sales, which ignore car purchases, rising 0.4% after a 0.2% increase previously.

"We expect inflation to have edged up to 2.3% in January and retail sales to have risen slightly in December," says Stephen Brown at Capital Economics.