GBP/CAD Rate in Runaway Train Mode and Could Top 1.56 Short-term

• GBP/CAD in runaway recovery with 1.56 in sight
• Could rise further if USD/CAD reverses to upside
• But GBP/CAD also risks setback near to 1.5350

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The Pound to Canadian Dollar exchange rate has surged to six-week highs in recent trading but could climb further in the short-term and potentially above the 1.56 handle for a time, although the rally underway is not without setback risks and these could intensify as the new month unfolds.

Sterling rallied early in the new week with gains over all major currencies and in price action that many observers connected to an about-face from the UK government on some of its latest budget proposals including a decision to cut taxes for the top one percent of earners as part of its growth plan.

"After facing an internal revolt amongst Tory rebels, Truss/Kwarteng abandon plans to cut the tax rate of the top 1% to 45%. Our take: A humiliating U-turn for Truss – just a few weeks into her tenure," says Bipan Rai, North American head of FX strategy at CIBC Capital Markets. 

"GBP/USD still feels like a fade from these levels. That’s contingent on how far this USD squeeze will run in the short-term," Rai said in Monday commentary.

Sterling has steamrolled higher, taking GBP/CAD back above 1.50 on Monday and as far as 1.55 in the Tuesday session, marking its highest level since the middle days of August in what is a quiet week for the UK economic calendar.

Above: GBP/USD shown at hourly intervals alongside GBP/CAD and an upside down Dollar-Canada rate.

The main Sterling pair GBP/USD had overshot by Tuesday its pre-budget levels around 1.12, however, potentially leaving it vulnerable to any corrective rebound from a U.S. Dollar that has come under widespread pressure of late.

"Despite yields calming, it would be prudent to expect further sterling volatility," says Harry Adams, CEO at Argentex, a publicly quoted and London Stock Exchange listed specialist in commercial foreign exchange services.

"The intrinsic issue is the lack of demonstrable and empirical evidence that the government’s policy measures will help rectify some of the critical economic issues facing the UK. The government’s view on growth initiatives, and that of the markets, are still very distinct," Adams said on Tuesday. 

None of this means the GBP/CAD rally cannot extend further in the short-term, however, as much about the outlook for this exchange rate also depends on how the Canadian Dollar itself is able to hold up against the U.S. Dollar during what will be a busy period for U.S. and Canadian economic newsflow.

"The CAD retains a very strong, positive correlation with US equities (+87% on a rolling 1m study of daily returns) and remains one of the most highly correlated G10 currencies with risk sentiment across our major currency screen," says Shaun Osborne, chief FX strategist at Scotiabank.

Above: GBP/USD shown at 4-hour intervals alongside GBP/CAD and an upside down Dollar-Canada rate.

"Holding the 1.12 area would be a technical plus and point to further, corrective gains to the 1.14+ zone," Osborne said in a Monday reference to the main Sterling exchange rate GBP/USD, which has implications for GBP/CAD.

GBP/CAD always tends to closely reflect the relative performance of Sterling and the Loonie when each is measured against the U.S. Dollar and would likely rise further, potentially to 1.56 or more, if North American newsflow leads USD/CAD to begin reversing its Monday and Tuesday declines.

However, on the other hand, a continuation of the opening Loonie rally would potentially risk pushing GBP/CAD back below 1.55 and as low as something like 1.5350 if the author's rudimentary estimation is anything to go by. 

"RBC Economics expects the employment report (Friday) to show some improvement after three straight monthly declines. Summer seasonal distortions are expected to fade in September, fueling a 15K increase in overall employment," says Alvin Tan, head of Asia FX strategy at RBC Capital Markets. 

"That's a welcome uptick, though it still leaves the jobs count down by almost 100K compared to May. The unemployment rate is expected to hold steady at 5.4%, which would still be strong as it is well below pre-pandemic levels despite rebounding from June's record low of 4.9%," Tan said on Monday.

Above: GBP/USD shown at daily intervals alongside GBP/CAD and upside down Dollar-Canada rate.

The highlight of the week for the Canadian Dollar is the Friday release of September's jobs report, which could impact perceptions and expectations of the outlook for Bank of Canada (BoC) monetary policy.

However, this comes at the same time as last month's non-farm payrolls report from the U.S. and both of these data points are preceded by a raft of other figures coming out of the U.S. as well as public appearances from a number of Federal Reserve (Fed) policymakers. 

The collection of data out this week potentially leaves the Canadian Dollar vulnerable relative to the U.S. Dollar and other currencies, which would be positive for GBP/CAD. 

"Last week, we wrote about our more bearish view on the Canadian dollar, arguing that the slowdown in the country was gaining speed, that housing prices were rolling over, and that mortgage payments were rising," says John Velis, an Americas FX and macro strategist at BNY Mellon.

"The Bank of Canada, meanwhile, was expected by markets to slow the pace of its rate hikes. We also noted that in the last few weeks, the CAD had weakened not only against the USD but also on crosses. It’s not just general USD strength that is currently pushing CAD lower, rather the cocktail of factors mentioned above," Velis wrote in a Monday research briefing.