Pound / Canadian Dollar Week Ahead Forecast: Upside Limited as BoC’s Big Day Looms

• GBP/CAD could slip 1.6930 on ‘hawkish’ BoC
• ‘Dovish’ stance could lift GBP/CAD to 1.7180
• Ukraine invasion neutral-to-bearish GBP/CAD
• Any successful defence a modest upside risk

Image © Bank of Canada

The Pound to Canadian Dollar exchange rate advanced strongly to open the new week but could struggle to rise much beyond its Monday levels without a ‘dovish’ surprise in Wednesday’s eagerly-awaited Bank of Canada (BoC) monetary policy decision.

Pound Sterling notched up strong gains almost all major counterparts on Monday in an opening rally that helped to unwind some of last Friday’s hefty loss, although it still remained the worst performer in the G10 contingent of major currencies for the recent week.

Canada’s Dollar fared better during a period in which major reserve currencies were sold heavily while commodity counterparts outperformed, although it didn’t do as well as the Norwegian Krone or the Australian and New Zealand Dollars.

“The Ukraine conflict will boost oil prices in the short run. The longer-term global growth impact is uncertain but will undoubtedly stoke inflationary pressures. The Fed and the BoC will push on,” says Mark McCormick, global head of FX strategy at TD Securities.

“We positioned for this type of setup yesterday, adding GBPCAD shorts,” McCormick also said in a note to clients last Thursday.

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

• Reference rates at publication:
  GBP to CAD spot: 1.7050
• High street bank rates (indicative): 1.6450 - 1.6570
• Payment specialist rates (indicative: 1.6895 - 1.6963
• Find out about specialist rates and service, here
• Set up an exchange rate alert, here

Russia’s incursion into Ukraine last Thursday and its ongoing attempt to topple the government by force remain a neutral-to-bearish influence for GBP/CAD but this week the Loonie’s fortune will also be determined in no small part by the BoC’s latest policy decision and market response to it.

“Canada's direct trade exposure to Russia and Ukraine is small, and the domestic economy and inflation is too strong to justify the current emergency levels of interest rates,” says Alvin Tan, Asia head of FX strategy at RBC Capital Markets.

The BoC is widely expected to take the first step in a process to reverse the interest rate cuts that were announced in support of the economy back in March 2020 this Wednesday, which is likely to see the bank lift its cash rate from 0.25% to 0.50%.

Wednesday’s rate rise itself is unlikely to excite the Canadian Dollar by much although any remarks that could indicate the likely pace of subsequent changes in the benchmark could be impactful while anything the bank says about its government bond holdings would also be important too.

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“The policy statement (or the governor’s speech) may provide more insight into the plans to run down the balance sheet in the coming months. We think the statement will tilt hawkish,” says Shaun Osborne, chief FX strategist at Scotiabank.

“The BoC may anchor the CAD—and perhaps provide some impetus for CAD gains on the crosses where monetary policy prospects are less certain—but broader CAD gains will have to await calmer markets and a general decline in risk aversion/volatility,” Osborne and colleagues said on Friday.

Remarks on the bond holdings are important because the BoC is also widely expected to begin shrinking its balance sheet at some point this year, after buying up more than 40% of all Canadian government bonds as part of its pandemic-inspired quantitative easing programme.

This process is something that could potentially have a powerful uplifting impact on government bond yields, as well as on the Canadian Dollar.

Above: USD/CAD shown at daily intervals.

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Any surprise decision to begin the “quantitative tightening” in February or within a short space of time after could draw a bid from the market for the Canadian Dollar, which would have adverse implications for GBP/CAD and even more so if the U.S. Dollar remains on its front foot at the same time.

“USD gains through the recent range highs around 1.2790/00 and a pickup (albeit from weak levels still) in daily and weekly trend momentum oscillators tilt risks towards a stronger USD in the week ahead but, considering the solid resistance seen in the 1.29/1.30 range over the past year, short-term USD gains still face relatively limited upside potential at this point,” Scotiabank’s Osborne says.

The Pound to Canadian Dollar rate is sensitive to the trajectory and performance of USD/CAD, which could potentially be pulled beneath Monday’s 1.27 level and back toward an important level of support around 1.2664 in response to any BoC tailwind.

That would risk pushing GBP/CAD back beneath 1.70 this week if by that time the main Sterling exchange rate, GBP/USD, has not been able to advance meaningfully beyond Monday’s level of around 1.34 as the former tends to closely reflect the relative performance of GBP/USD and USD/CAD.

This potentially leaves much to be determined by the broad trajectory of the U.S. Dollar, which is itself likely to be a function of developments on the ground in Ukraine and their impact on risk appetite across global markets.