GBP/CAD Week Ahead Forecast: Rate Cut Underpriced

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The Pound to Canadian Dollar exchange rate (GBP/CAD) has had a strong run of late, but last week we saw some selling pressure mount amidst a correction from overbought conditions.

The coming week could prove to be a cracker for this exchange rate as the Bank of Canada could cut interest rates and reignite CAD weakness.

"We think markets are underpricing the risk of a June cut, which stands between 50-60% currently, and underestimating the scope for policy divergence," says a note from Goldman Sachs.

If the Bank of Canada does decide to cut interest rates, there is a high likelihood of a significant CAD selloff, especially considering that the market has not fully priced in this possibility.

A number of analysts argue that the Bank will prefer to cut interest rates closer to the U.S. Federal Reserve's first rate cut in order to minimise any potential financial market risks and CAD weakness.

But the Canadian economy is clearly underperforming relative to its southern neighbour and economists see any delay as potentially hurting the economy further, meaning the Bank will ultimately have to cut rates more further down the line.

Above: GBPCAD at daily intervals. GBP/CAD is still in a constructive technical setup, although of late, it has corrected from overbought conditions (RSI in the lower panel had breached 70, which indicates oversold). Track GBP/CAD with your own custom rate alerts. Set Up Here 

"Underlying inflation momentum in Canada has clearly slowed over the past few months and growth been more sluggish than both market expectations and the BoC’s April projections. Altogether, we think the latest data meet the Governing Council’s goal of “sustained” easing in core inflation and should push them to ease," says Goldman Sachs.

If the Bank does proceed with a rate cut we would look for GBP/CAD to recover much of last week's selloff and potentially retest the 2024 highs at 1.7453.

How far GBP/CAD rises would likely depend on the tone adopted by the Bank of Canada; should it cut rates but warn against expecting further rate cuts, GBP/CAD weakness could be limited in scope.

Under such a scenario there is a good chance GBP/CAD closes the week lower than where it opened.

We also note GBP/CAD has had a strong run over recent months, and we wonder if this move means the Bank of Canada's looming interest rate cutting cycle has been fully accommodated by the exchange rate.

If this is the case, the odds of a decisive break to fresh 2024 highs could prove limited and those with CAD purchase requirements should be proactive around and CAD weakness.

If the Bank of Canada opts to keep interest rates unchanged there is a strong chance CAD rallies and pushes GBP/CAD into a consecutive weekly decline.

"The risk is the BoC stands pat this week," says Kristina Clifton, Senior Economist and Senior Currency Strategist at CBA. "The market is only pricing about 57bp of cuts this year, including 20bp for this week’s meeting. While we expect a total of three cuts this year, a dovish repricing may be limited this week if the BoC sends a cautious message on future rate cuts."

Some analysts say the Bank will prefer to wait until July in order to gather further confirmation inflation is falling back to the 2.0% target.

"We expect the BoC to stay on hold on Wednesday," says a weekly FX briefing from Barclays. "While the bank has indicated that inflation is moving in the right direction, it has also stated that it wants to see this for longer to be confident that progress will be sustained. As such, we expect the bank to wait for the July meeting to deliver its initial 25bp rate cut."

"A hold in June shouldn’t be a game changer for the CAD: the direction of travel is still toward policy divergence vis-à-vis the US and we remain bearish the currency," adds the briefing.