Pound-Canadian Dollar Rate Tumbles after BoC Stays Policy Course

Above: BoC Governor Macklem. Image © Bank of Canada, Reproduced Under CC Licensing

• GBP/CAD spot rate at time of writing: 1.7227
• Bank transfer rate (indicative guide): 1.6624-1.6745
• FX specialist providers (indicative guide): 1.6969-1.7106
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The Pound-to-Canadian Dollar exchange rate tumbled on Wednesday after the Bank of Canada (BoC) stayed its earlier established course by leaving the cash rate unchanged following its latest meeting, surprising some parts of the market, and continuing its commitment to quantitative easing.

Canada's central bank left the cash rate unchanged at 0.25% following January's meeting of the Governing Council and committed to continue buying "at least $4 billion per week," of Canadian government bonds in a bid to see the low cash rate passed on to households and companies.

The BoC's quantitative easing programme enables it to force down government bond yields through purchases of the relevant government debt in the secondary market, which offers benefits to all Canadian business and household debtors because government yields represent the local 'risk free' rate and so get baked into all new loans made and interest rates charged across the economy. 

"The resurgence of cases and the reintroduction of lockdown measures are a serious setback. Growth in the first quarter of 2021 is now expected to be negative," the BoC said. "The Canadian economy will continue to require extraordinary monetary policy support. The Governing Council will hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. In our projection, this does not happen until into 2023. To reinforce this commitment and keep interest rates low across the yield curve, the Bank will continue its QE program until the recovery is well underway.  As the Governing Council gains confidence in the strength of the recovery, the pace of net purchases will be adjusted." 

Canada's rate setters cited the earlier than anticipated rollout of coronavirus vaccines as grounds for optimism about the economic outlook but warned of elevated short-term uncertainties, which is pertinent for Canadians in light of tightened restrictions on social contact and commercial activities that have been reimposed in many provinces since November last year. 

Above: Pound-to-Canadian Dollar rate shown at 15-minute intervals alongside USD/CAD (blue). 

"Vaccines are riding to the rescue of the Bank of Canada’s economic outlook. But with the pandemic still raging for now, the Canadian dollar perhaps looking at bit too strong and inflation too low for its liking, the Bank of Canada underscored that it will be very patient in deciding when to take its foot off the gas," says Avery Shenfeld, chief economist at CIBC Capital Markets. "We expect the Bank to further taper its bond buying program in April to avoid owning too much of the outstanding market, but rate hikes aren’t in the cards until 2023 (that’s the first year for sustained 2% inflation) and particularly, likely not until the Fed has moved first to avoid pushing the loonie still stronger." 

The BoC forecasts the economy to grow at an annualised pace of 4% in 2021 and by nearly 5% next year, although it won't be until 2022 that Canada has backfilled the -5.5% decline in GDP that was seen last year and it's expected to be even longer before the so-called 'output gap' is closed.

The latter is necessary for the BoC to be confident that the economy can sustainably deliver inflation that averages 2% each year, and it's inflation that central banks are seeking to manage or otherwise manipulate when they tinker with interest rates and alter other monetary policies.

Canadian inflation turned negative on a month-on-month basis in December, Statistics Canada data showed on Wednesday, having fallen -0.2% last month although the more important rate of core inflation fell -0.4%. The annual rate of inflation was just 0.7%, far below the BoC's target.

"USDCAD has given up the 1.2670-1.2730 support zone, and is falling apart here in the wake of the Bank of Canada’s latest," says Eric Bregar, head of FX strategy at Exchange Bank of Canada. "Market chatter is citing the central bank’s unexpectedly higher inflation outlook for Q4 2020 and into Q1 2021 as the culprit. However, we can’t say this plunge in USDCAD is all Bank of Canada driven because the S&P and Nasdaq futures exploded higher to new all time highs at the 10amET hour as well, so there are suddenly big “risk-on”, USD-suppressive, flows in play as well."

Above: Pound-to-Canadian Dollar rate shown at daily intervals alongside USD/CAD (blue). 

Wednesday's decision was in line with the economist consensus although there had been suspicions, fears or otherwise expectations in some parts of the market before the decision that the bank might announce a 'micro cut' to the cash rate in order to provide more support to the economy as well as to lean against an increase in Canadian exchange rates.

"Some investors were hoping that the BoC would slightly reduce the lower bound of its key rates. Still, the monetary authorities have closed the door by reiterating their intention to leave the target for the overnight rate at its lower bound of 0.25% until 2023," says Benoit Durocher, an economist at Desjardins. 

Some Canadian exchange rates have risen notably in recent months, although due mainly to the effect of a depreciating U.S. Dollar. This led Governor Tiff Macklem to warn during a December address to the Greater Vancouver Board of Trade that rising exchange rates could later hold back Canada's economic recovery, which explains not only why some had anticipated a Wednesday rate cut but also why the Canadian Dollar rallied when one wasn't delivered. 

The Pound-to-Canadian Dollar exchange rate tumbled alongside USD/CAD following the decision, although price action comes ahead of the inauguration of President Elect Joe Biden, whose first action once inside the White House could be to cancel the permit for the Keystone XL pipeline that would pump oil from Canada, across the southern border and into the world's largest economy. Any such outcome would be a blow for the Canadian export outlook and the Loonie. 

"Note that one of Biden’s first actions as president may be to halt the Keystone XL pipeline," warns Shaun Osborne, chief FX strategist at Scotiabank. "Trend signals are weak and neutral across short, medium and longer term time frames which suggest the GBP will continue to bounce around randomly between support around 1.72 (reinforced by the 200-day MA) and resistance at 1.75. We do think, however, that a push through 1.7440/45 will tip the balance towards a topside break out —price patterns suggest this may be the neckline of a bullish, inverse Head & Shoulders formation forming within the broader range trade."

Above: Pound-to-Canadian Dollar rate shown at weekly intervals alongside USD/CAD (blue).