Canadian Dollar Forecasts vs. Pound and U.S Dollar 2021: Too soon to Expect Strength says BofA

- CAD seen at risk of weakness into 1st quarter 2021
- More sustained recovery possible in 2021
- But current account deficit remains a headwind
- Canada likely to see capital inflows increase

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• GBP/CAD spot rate at time of writing: 1.7345
• Bank transfer rate (indicative guide): 1.6704-1.6825
• FX specialist providers (indicative guide): 1.7223
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The Canadian Dollar will strengthen in 2021 say analysts at Bank of America, driven by stronger investor inflows of capital and rising oil prices.

However, the currency could still experience a challenging end to 2020 before it embarks on a more sustained trend of appreciation, owing to short-term challenges facing the domestic and global economy.

"Presently-low CAD risk premium appears inconsistent with the range of shorter-term challenges faced by the global economy, principally the surge virus infections against a backdrop of no new policy support," says Ben Randol, a foreign exchange analyst at Bank of America (BofA).

While positive news surrounding the effectiveness in three covid-19 vaccines has prompted a strong rally in risk-aligned assets in November - such as the Canadian Dollar - the full deployment of vaccines still remains a relative unknown.

But, most economists and medical specialists are looking for vaccines to be deployed in a meaningful manner in major Western economies in the first quarter of 2021, which could ultimately provide support to equity markets and oil prices, creating the conditions supportive of a more sustained Canadian Dollar appreciation.

The Canadian Dollar is a 'high beta' currency in that it has a strong positive correlation with investor sentiment, typically as expressed via the S&P 500 stock index.

Therefore, strong global growth is a naturally supportive backdrop for the Canadian Dollar.

"We have become increasingly sanguine on prospects for the global cycle, assuming widespread availability and take-up of a vaccine, which will facilitate the recovery process. In turn, improved risk appetite and moderately higher oil should impart gradual trend appreciation and – we suspect – overshoot in CAD next year amid generalized USD softness," says Randol.

Bank of America say Canada's external financing risks still remain significant, but they expect to see an improvement as 2021 unfolds.

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The financing risks were confirmed after Canada on November 30 reported a larger deficit in trade in goods and services for the third quarter of 2020, a deficit which was moderated somewhat by a higher investment income surplus in the quarter.

The current account deficit in Canada widened to $7.5BN in the third quarter of 2020 from a downwardly revised $7BN in the previous period but came much smaller than market forecasts of a $9.1BN gap.

A persistent deficit means that for the Canadian Dollar to stay stable, or appreciate, an inward flow of foreign capital investment must be maintained, or grow.

Therefore, much of the Canadian Dollar's fundamental outlook depends on how willing international investors are to balance the country's external books by investing in Canada.

When the global economy is growing and investor sentiment is positive it is naturally more likely that these decisions are made and inflows materialise.

"Portfolio flows have generally been weak in the context of twin deficits in the current account and net direct investment. But we are optimistic that appetite for Canadian assets can increase as Covid-19 fades and the global recovery re-accelerates," says Randol.

Bank of America have revised their forecasts for the Canadian Dollar on a "more sanguine outlook for global recovery next year."

They expect a near-term rise in the U.S. Dollar-Canadian Dollar exchange rate to 1.34 in the first quarter of 2021 on a temporary rebuild in Canadian Dollar risk premium, moderating back to 1.29 by mid-year 2021 as the global economy, oil prices and risk-appetite further recover.

However, the appreciation in the value of the currency might be greater should the global economic recovery be more robust than envisioned, allowing the strengthening Canadian Dollar to push USD/CAD down into the mid-1.20s.

But, "a bumpy recovery risks a return to the mid/high-1.30s," says Randol.

USD/CAD is currently forecast at 1.34 by the end of March 2021 and 1.32 by the end of June 2021. by the end of September it is forecast at 1.29, close to the current spot rate of 1.2958.

Utilising BofA's GBP/USD and USD/CAD forecasts we are able to establish the Pound-to-Canadian Dollar exchange rate forecasts. GBP/CAD is seen at 1.74 by the end of March and 1.73 by the end of June 2021.

The current spot GBP/CAD exchange rate is at 1.7300.