Pound-Canadian Dollar Rate Pained by Brexit Pessimism as Outlook Balances on Knife Edge

- GBP/CAD knocked lower by Brexit pessimism and CAD strength. 
- UK Gov said to lose hope for Brexit trade deal as talks near end.
- USD/CAD threatens more losses for Brexit stricken GBP/CAD.
- But Brexit deal still possible, would drive GBP/CAD above 1.75. 

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The Pound-to-Canadian Dollar rate was under pressure Wednesday after The Telegraph reported the British government has all but given up hope of reaching a trade agreement with the European Union, leaving the outlook for Sterling balanced on a knife edge just as the Canadian Dollar recovers its footing. 

Prime Minister Boris Johnson and government are reported to now be working on the assumption the UK will trade with the European Union according to World Trade Organization rules and with most-favoured-nation tariff rates after the transition period ends with 2020. 

The revelation comes as accelerated negotiations near their end with no further talks scheduled beyond this week so if Thursday's update from negotiators reveals that progress is still lacking then investors might become more conscious of the seemingly rising Brexit risks associated with holding Sterling. 

"While the EU believe the real deadline for a deal is October they will offer hope that not all is lost but the risks of no deal are certainly escalating," says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG. "Our sense is that markets remain convinced a deal will be done but that is set to be questioned more seriously over the coming weeks."

Above: Pound-to-Canadian Dollar rate shown at 15-minute intervals.

GBP/CAD received a boost in noon trading after Statistics Canada said inflation rose from 0.3% to 0.8% in June, an overshoot of the consensus expectation for an increase to only 0.4%, although Sterling remained lower for the day. 

In normal times inflation surprises might stoke expectations of an interest rate rise, resulting in currency strength, but in 2020's coronavirus contaminated world where rates are seen near zero for a considerable period, rising inflation simply risks slower economic growth and is a net negative for currencies. 

The Pound-to-Canadian Dollar rate rebound was quickly quashed and the outlook for the exchange rate is increasingly balanced on a knife edge given that Brexit risks are weighing on GBP/USD at a point when the USD/CAD rate is breaking down into a new lower range. Without a pickup in GBP/USD, this could lead to more losses for the Pound-to-Canadian Dollar rate.

"Yesterday's break below 1.3450 was swift, but it didn't stand out in a major USD selloff. In fact, CAD didn't outperform AUD. That would be expected in a stop-loss cascade because the market was already net long of AUD but had remained net short of CAD. We take that as a sign that the more critical stops are lower still. We would point to 1.3350 as being more critical than 1.3450," says Greg Anderson CFA, global head of FX strategy at BMO Capital Markets. 

Above: USD/CAD rate shown at daily intervals alongside GBP/USD (orange line).

Anderson says U.S. Dollar losses are lowering the equilibrium for USD/CAD, based on observations of the BMO rotating-financial-factor model, which currently identifies the Dollar Index as the number one variable driving that Canadian exchange rate. Previously price action has taken its lead from the S&P 500, the Asian Dollar Index and copper prices, among other things. 

USD/CAD's fair value equilibrium was around 1.3391 on Wednesday, below the 1.3426 level prevailing on the interbank market, which is problematic for the Pound-to-Canadian Dollar rate in a market where Sterling isn't also charging higher against the U.S. Dollar. Both GBP/USD and USD/CAD were lower, explaining losses that dragged GBP/CAD back to 1.7078, although Anderson says BMO's model would advocate taking-profits if USD/CAD hits 1.3391.

The Pound-to-Canadian Dollar rate would fall to 1.7008 if USD/CAD hit 1.3391 while GBP/USD trades around 1.27, but likely profit-taking would susbequently lift USD/CAD and could mean that a step-up in GBP/USD losses is required in order for the Pound-to-Canadian Dollar rate to get back below 1.70. It's not clear if or how soon GBP/USD losses could escalate given that many investors' are increasingly reluctant to hold the greenback, indicating that GBP/CAD might be finding a firm foothold around 1.70.

"The 200-day MA appears to be contributing to a slowdown in the GBP’s rise and blunting near-term trend strength. However, we note that the June/July sideways movement in the GBP may be developing an inverse Head & Shoulders pattern—with the 1.7175 area effectively designating the bullish break out point. The chart formation implies upside potential of a little over 400 pips on a clear move above the neckline trigger," says Juan Manuel Herrera, a strategist at Scotiabank, of the GBP/CAD rate. 

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

The Pound-to-Canadian Dollar rate has been trading in a narrow range this week but recent price action has left in its wake on the charts the 'inverse head & shoulders pattern' flagged by Scotiabank, which could trigger a rally to around 1.7575 if a daily close above 1.7175 level is achieved. This would require a strong rally in either GBP/USD or the now-downtrending USD/CAD rate. 

A rally in GBP/USD cannot be ruled out for the coming days and weeks because a last minute agreement with the EU is still possible. 

European demands for a substantial share of British sustainable fishing opportunities and a role for itself as a supervisory probation officer to a post-Brexit UK economy, via a so-called level playing field agreement, have seen the talks descend into deadlock since their beginning earlier in July. These and others would require the UK to closet-index policy to that of Brussels in a range of areas and would impose penalties for non-compliance, rendering the Brexit excercise a largely null, void and pointless pursuit. 

Prime Minister Boris Johnson, who has a large if-not insurmountable majority in the House of Commons, and UK negotiator David Frost have called out and criticised European manoeuvres in a manner that was previously uncharacteristic of the British side. But Johnson has form for adopting tough stances in negotiations only to fold at the last minute, with another bout of deadlock having given way in October 2019 to a request for an extension of the Article 50 countdown period to EU exit. This was after campaigning for the Conservative Party leadership on a pledge to not request such a thing.

Above: Pound-to-Canadian Dollar rate shown at weekly intervals with 21. 55 (red) & 200-week (green) moving-averages.