GBP/CAD Rate's Attempted Recovery Could Extend Further 

• GBP/CAD’s recovery attempt could extend to 1.53
• If UK's new PM revives GBP & BoC burdens CAD
• UK’s energy policy in focus ahead of BoC decision
• BoC cash rate seen at 3.25% but outlook unclear

The Bank of Canada, Ottawa. Image reproduced under CC licensing conditions

The Pound to Canadian Dollar exchange rate rallied from 12-year lows early in the new week and could potentially advance further toward 1.53 in the days ahead if given the right combination of policies from the new UK government on Tuesday and the Bank of Canada (BoC) on Wednesday. 

Sterling rose broadly to open to the new week including against the Canadian Dollar amid speculation over a possible package of UK government measures aimed at preventing a high single digit multiplication of household energy prices from causing economic calamity later this year.

UK energy prices are expected to rise by another 80% with October’s tariff change, leaving them around eight times the levels seen in the third quarter of 2021, although speculation is that new Prime Minister Liz Truss will announce public funding to cover these on Tuesday evening.

“On its own, that could take our forecasts for UK inflation from 12.8% yoy to c10% for Q4 and from 13.3% to c9.5% for Q1,” says Holger Schmieding, chief economist at Berenberg. 

“So far, the UK has offered less support to households than most other European countries. If Truss goes ahead with the reported idea, the UK would go super-European, intervening more than many EU governments,” Schmieding said on Tuesday.

Above: Pound to Canadian Dollar rate shown at hourly intervals alongside USD/CAD. 

Reportedly, the funding would be provided to energy companies directly in a way that would prevent increases in consumer prices, meaning it would also technically limit any further increases in inflation rates while also lessening a widely anticipated economic downturn later this year.

Furthermore, and reportedly, there is a desire to increase domestic production in the North Sea and an intention to scrap a moratorium on fracking, which could be a more effective medium or longer-term solution for prices and a policy that is supportive of economic growth.

“The news appears to partially ease the market’s concerns (that have weighed on GBP) that Truss’ promised tax cuts would ultimately worsen the inflation picture. The pound is set to face further volatility in the coming days as Truss’ policy plans are outlined in greater detail and the Bank of England meeting (15 September) draws nearer,” says Francesco Pesole, an FX strategist at ING. 

Details emerged late on Monday and were followed by a widespread rebound in Sterling that carried over into the Tuesday session, although nothing has been announced officially and the Pound to Canadian Dollar rate also has a Bank of Canada interest rate decision to contend with on Wednesday.

“We expect a 75bps increase in the Overnight Target Rate, which is pretty much fully priced in swaps. This is a statement-only affair so we may not get too much colour on the outlook for policy but the Bank seems likely to persist with its strong messaging on curbing inflation which tilts risks towards a further, cumulative 75bps of hikes at least in the next few months,” says Shaun Osborne, chief FX strategist at Scotiabank. 

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

“Note that opinion polling suggests the Bank’s communication strategy is resonating with the public who are more persuaded that it remains committed to its inflation target. The rate decision overshadows the Trade and Ivey PMI data Wednesday while jobs data Friday may not have much impact on the CAD if BoC messaging remains hawkish,” Osborne said on Friday.

The BoC lifted its cash rate from 1.75% to 2.5% in July as part of a strategy to move monetary policy to an economically restrictive level sooner rather than later so as to protect the economy by limiting the extent to which interest rates might need to rise over the medium-term.

That restrictive level is deemed by the BoC to involve a cash rate that is anywhere above the 3% level, although interest rate derivative market pricing suggests that investors already expect the benchmark to rise further and as far as 3.75% by year-end. 

This could mean the market will be most interested in any guidance given on Wednesday about the likely size and pace of future increases in the cash rate, making that the most important factor for GBP/CAD ahead of this Friday’s Canadian labour market figures.

“The Bank's commitment to front-loading rate hikes in the face of red-hot inflation means an even bigger 100 bps increase (matching July's hike) can't be ruled out. Canadian employment (Friday) is expected to rise 5K in August following two consecutive monthly declines. The unemployment rate is expected to increase to 5.0%, which is still very low,” says Alvin Tan, head of Asia FX strategy at RBC Capital Markets.

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