GBP/CAD Week Ahead Forecast: BoC Conditionality in Focus

The Pound to Canadian Dollar exchange rate has further consolidated a multi-month recovery in recent trade but could attempt to reclaim earlier lost ground around the 1.63 level this week if January's inflation data vindicates the Bank of Canada's (BoC) conditional pause in its interest rate cycle.

Canada's Dollar edged higher against most major currencies to open the new week and remained one of the top performers for the February month following broad gains that have helped to keep GBP/CAD under wraps and in a consolidation pattern near an important trend inflection point on the charts. 

Sterling has, meanwhile, underperformed a solid majority of its most directly comparable peers but despite this GBP/CAD has appeared to dig its heels in when near the round number of 1.61, which coincides closely with a Fibonacci support level and a 100-day moving average. 

But inflation and retail sales figures out of Canada on Tuesday will help to determine whether the Pound makes a gambit for the land below there, or if it instead attempts to resume a multi-month recovery dating back to late September's all-time low of 1.4069.

"Canadian inflation pressures are expected to have lightened up again in January, with headline inflation growing at 6.1% in Tuesday’s release (prev. 6.3%)," writes Elsa Lignos, global head of FX strategy at RBC Capital Markets, in Monday market commentary.  

Above: Pound to Canadian Dollar rate shown at daily intervals with Fibonacci retracements of November rally and selected moving averages. Click image for closer inspection. 

"Core CPI is also expected to have edged lower again, to 5.1% y/y, with the Bank of Canada’s preferred CPI trim and median measures likely to tick lower as the breadth of Canadian inflation pressures gradually narrows. Canadian retail sales likely rose by 0.5% in December (also on Tuesday), in line with the advance estimate from StatCan," she adds. 

Canada's overall and core consumer price inflation rates are widely expected to ebb by 10 basis points each for the month of January on Tuesday but there may be a risk of an unchanged reading that would be almost sure to give the Bank of Canada cause for consternation. 

This is after January inflation figures defied gravity and market expectations across the border in the U.S. last week, and the risk would be of a repeat performance in Canada on Tuesday if inflation dynamics between the two countries are in any way similar to the labour market dynamics. 

Canada's labour market echoed the strength and resilience of its larger North American counterpart in January when adding a significantly larger amount of new jobs than had been expected by economists, though there is uncertainty over whether the inflation data can be expected to follow suit.

"The feeble moderation in US inflation in January did little to assuage hawkish concerns raised following the strong nonfarm payrolls report two weeks ago. Neither did producer prices, which jumped 0.7% in January, almost doubling the median consensus forecast," says Jimmy Jean, chief economist at Desjardins.

Above: Financial model-derived estimates of probable trading ranges for selected currency pairs this week. Source Pound Sterling Live. (If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.)

"Closer to home, food inflation remains in the double digits, and recent headlines over relentless price pressures in the grocery sector have been disheartening enough to earn supermarket CEOs an invitation to a grilling session on Parliament Hill," Jean writes in a Friday research briefing.

Among the most negative combinations possible for GBP/CAD this week would be stubbornly elevated Canadian inflation and stronger-than-expected December retail sales figures, which would potentially lead the BoC to wonder if it was such a good idea to pause its interest rate cycle in late January.

Those kinds of outcomes in Canada would be especially burdensome for GBP/CAD if combined with a soft set of S&P Global PMI surveys from the UK on Tuesday, as the latter would vindicate the Bank of England (BoE) for having turned non-committal in February on the outlook for Bank Rate.

"Both Canada CPI and retail sales could beat Bloomberg consensus, which would benefit CAD if the market prices further BoC hikes (as happened after the Jan employment report). However, our view is that the BoC is very likely to be on pause in March," says Michael Cahill, a strategist at Goldman Sachs.

"Our GS MAP surprise index is strongest right now in Canada and the US. However, we think there is a divergence between the BoC, which has been direct in its intention to pause, and the Fed, where recent commentary has turned more hawkish. This could present a good tactical trading environment through the upcoming BoC meeting," Cahill adds in Monday commentary. 

Above: Pound to Canadian Dollar rate shown at weekly intervals with Fibonacci retracements of September recovery and selected moving averages. Click image for closer inspection. To optimise the timing of international payments you could consider setting a free FX rate alert here.

The BoC lifted its cash rate to 4.5% at the end of January but also said it intends to hold borrowing costs at current levels while observing the economic effects of the eight separate increases announced between then and March 2022. 

"This is a conditional pause—it is conditional on economic developments evolving broadly in line with our forecast," BoC Governor Tiff Macklem told the House of Commons Standing Committee on Finance last week. 

"We expected economic growth to be close to zero for the first three quarters of the year. With growth in demand stalled, supply will catch up and the economy will move from excess demand to modest excess supply. This will relieve inflationary pressures. We expect CPI inflation to fall to around 3% in the middle of this year and reach the 2% target in 2024," he said of the forecast.

Since January Statistics Canada figures have painted the local labour market in a robust light, albeit while also suggesting a moderation of wage and salary pressures, while third-party forecasters' have continued to anticipate modest growth for the Canadian and global economies this year.

Hence why Tuesday's inflation and retail sales figures could have a formative influence on the outlook for Canadian interest rates and GBP/CAD.