GBP/CAD Rate Feeling Out New and Lower Trading Range

• GBP/CAD could have bottomed around 1.40
• But recovery momentum fading near to 1.48 
• GBP/CAD's loss lessened by USD/CAD rally
• USD/CAD & overall USD trend key to outlook
• New, lower & potentially wide range possible

Image © Adobe Stock

The Pound to Canadian Dollar exchange rate has substantially reversed an earlier spectacular slump to all time lows from the opening session of the week but its recovery appeared to falter ahead of 1.50 and so the risk may be that its latest declines have opened up a new and lower trading range for Sterling.

Sterling rallied against all currencies during European trading on Monday and was higher again on Tuesday after unraveling at the seams previously in Asia when GBP/CAD fell to all-time lows of 1.40 before recovering near to 1.49 .

GBP/CAD was unable to recover the 1.50 level previously lost on Friday, however, and the rebound stalled on Monday when the Bank of England (BoE) indicated that its November meeting of the Monetary Policy Committee would not be brought forward as a result of the recent volatility in financial markets.

"The Bank is monitoring developments in financial markets very closely in light of the significant repricing of financial assets," Governor Andrew Bailey said. 

 "As the MPC has made clear, it will make a full assessment at its next scheduled meeting of the impact on demand and inflation from the Government’s announcements, and the fall in sterling, and act accordingly," he added in a partial conclusion.

Above: Pound to Canadian Dollar rate shown at hourly intervals alongside GBP/USD. Click image for closer inspection.

Monday's volatility appeared connected to Friday's budget-like announcement in which Chancellor Kwasi Kwarteng unveiled a range of stimulatory policy commitments that are almost certain to require significant increases in government bond issuance, and a higher budget deficit up ahead.

These went beyond the cancellation of tax increases planned by the prior government and were not limited to the simple provision of assistance relating to energy bills as they also included outright tax cuts as well as other giveaways, the announcement of which was followed by steep losses for Sterling.

"The net financing requirement has now increased by a substantial margin and will require an additional GBP62.4bln in gilt issuance. It’s not like the BoE will be around this time to mop this up via QE (in fact, they just announced they’re selling gilts last week)," says Bipan Rai, North American head of FX strategy at CIBC Capital Markets.

"The natural response to all this is a weaker GBP, and higher domestic yields. This shouldn’t surprise anyone considering the scale of external deficits the UK was running even before the fiscal plans were announced," Rai wrote in a Monday market commentary. 

All of this comes at a point when high inflation has gotten the BoE raising interest rates and looking to sell down its own portfolio of government bonds. 

Source: RBC Capital Markets.

The pending deluge of debt supply potentially necessitates currency and bond price discounts in order for it to find buyers, which is one prospective reason for the heavy falls of recent days, although it's also possible that some of the latest losses reflect bets against the Pound by speculative market participants.

"Most investors would prefer to steer clear of GBP right now, though as the chart above shows, atypically large volumes are going through," writes Elsa Lignos, global head of FX strategy at RBC Capital Markets, in a Monday contemplation of possible outcomes for Sterling.

"There is a lot of GBP changing hands despite the thin liquidity. Our best guess is that we’re in a new lower trading range in GBP/USD, marked by the Asia low to the downside and 1.10/1.11 to the topside," she added in an assessment that potentially says something about the outlook for GBP/CAD. 

At Tuesday's levels of USD/CAD, the above outlook for GBP/USD would imply a new, lower and very wide GBP/CAD range spanning the distance between 1.4162 and 1.5188, although both of these numbers might be either higher or lower in the event of any further rally or corrective declines in USD/CAD.

This is because GBP/CAD always closely reflects the relative performance of Sterling and the Loonie when each is measured against the U.S. Dollar.

Above: Pound to Canadian Dollar rate shown at daily intervals alongside USD/CAD. Click image for closer inspection.

USD/CAD is a wildcard in the outlook, however, following a steep September climb that came alongside a notable further strengthening of the U.S. Dollar against many currencies including a previously resilient Canadian Dollar.

"Financial market conditions are worsening in part as the UK government and Bank of England fail to provide sensible assurances to manage fiscal finances and contain the plunging currency. CAD is not immune to this deterioration in conditions," writes Mazen Issa, a senior FX strategist at TD Securities, in a Monday research note.

"We were bearish on the CAD for fundamental reasons as the debt servicing problem should start to manifest and create a data domino over the balance of the year, while worsening global growth meant that the currency would also be on the defensive. With oil prices in retreat as global demand wanes, CAD will continue to struggle," he added.

Canada's Dollar has been a consistent outperformer of most other major currencies during 2022 and was vying with the Swiss Franc for the second spot among G10 currencies on Tuesday but its losses against the U.S. Dollar have more than doubled within the space of the September month. 

This has effectively limited the scale of losses sustained by GBP/CAD, which might otherwise have fallen far below the 1.40 handle during Sterling's Monday sell-off, making both the trend in USD/CAD and in the U.S. Dollar important influences on the outlook for the Pound to Canadian Dollar rate. 

Above: USD/CAD shown at weekly intervals alongside USD/GBP and U.S. Dollar Index. Click image for closer inspection.