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Pound / Canadian Dollar Rate's Advance Could Have its Limits at 1.75: Scotiabank

Canadian Dollar 10

Image © Bank of Canada

- GBP/CAD hits cap at 1.75 and bounces down

- CAD seen as likely to outperform both Dollar and Pound

- GBP to flatline or fall as Brexit keeps BOE’s hands tied

The Pound-to-Canadian Dollar rate has hit a strong band of resistance at 1.75 which is capping upside and suggests downside risks are heightened, say Shaun Osborne, an analyst with Scotiabank in Toronto.

The exchange rate is quoted at 1.7496 at the time of writing, in line with a broadly stronger Pound, and the coming hours and days could determine whether this challenge of a significant technical level succeeds or fails.

“There is a strong band of resistance in the mid 1.75 area—defined by retracement resistance, the 40-day MA and the mid-Apr highs which may hinder progress,” says the analyst.

The Pound has advanced half a percent against the Canadian Dollar over the course of the past week but is still nursing a deficit for the past month.

Evidence that the Pound's recent rebound might be temporary in nature is the observation GBP/CAD has also probably formed a bearish topping pattern during March - “a weekly “evening star” reversal which rather suggests ongoing downside risks from our perspective—assuming that the mid 1.75 area continues to cap,” adds Scotiabank.

Whilst the pair was initially rejected by the 1.75 cap, it has since risen back up and retouched the level during today’s trading, nevertheless, it remains subdued.

Pound vs. Canadian Dollar

It is also possible to formulate a bearish fundamental bias to their GBP/CAD view based on comparing their relative analyses of how the two currencies are expected to trade versus the U.S. Dollar.

Scotiabank sees USD/CAD falling to the 1.3380s, based on their 'fair value' estimates.

A constructive outlook for oil, which recently breached the $70 per barrel level as well as a CAD-positive monetary outlook are the two main drivers of expected Canadian Dollar outperformance.

“The market tone remains constructive and oil prices also appear to be stabilising. Our Fair Value estimate (using the 2Y and 5Y spread, as well as WTI) is currently at 1.3381,” say Osborne.

Currency pairs are often driven by the relative difference between the interest rates in the two jurisdictions of the pair, such that capital flows tend to favour the currency with the higher rate, or the rate that is seen as more likely to rise.

“The outlook for relative central bank policy is dominating and yield spreads are narrowing in a CAD supportive manner as domestic rate expectations remain steady while Fed expectations soften into Wednesday’s FOMC,” says Osborne.

Comments from Stephen Poloz, the governor of the Bank of Canada (BOC), made before Canada's parliament on Tuesday did not diverge from the Bank’s official line that the economy will see growth pickup in the second half of the year, suggesting a CAD-supportive outlook for interest.

"The Canadian economy is currently facing some headwinds, but there is good reason to believe that the economy will accelerate in the second half of this year. In this context, the Bank’s Governing Council judges that an accommodative policy interest rate continues to be warranted. We will continue to evaluate the appropriate degree of monetary policy accommodation as new data arrive. In particular, we are monitoring developments in household spending, oil markets and global trade policy to gauge the extent to which the factors weighing on growth and the inflation outlook are dissipating," said Poloz in a prepared statement.

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Pound Won't Catch a Boost from the Bank of England

The Pound meanwhile is meanwhile unlikely to gain on interest rate expectations at the Bank of England’s (BOE) ‘hands are tied’ by political risk and it cannot change interest rates until Brexit is resolved.

The Bank of England will dominate currency market attention on Thursday, May 02 when they meet to deliver their latest policy decision and release the latest set of economic forecasts penned by their economists.

“Markets have assumed that no rate increases are likely while the Brexit process continues to play out but the extended delay in the process may leave policymakers uncomfortable with the idea that they are sidelined until late this year,” says Osborne.

It is worth considering one particular risk on the horizon which could run counter to a GBP/CAD decline and ought to be weighed in the mix, and that is that Labour and Conservative parties have restarted cross-party Brexit talks aimed at trying to broker a cross-party deal with a majority.

If they agree a compromise deal which wins the backing of the house, GBP would skyrocket.

Yet there seems little political incentive for Corbyn to broker a favourable deal with Theresa May given Labour’s current strong showing in polls so he is unlikely to offer May much in the way of compromise. It seems voters are blaming the Conservatives for the chaos around Brexit and Labour are gaining ground as a result.

From a purely strategic political point-of-view, the best thing for Labour to do is take a hardline stance on their preferred customs union form of Brexit and wait for the Conservatives to self-destruct. If they opt for the most politically expedient stance, which judging from their past behaviour looks highly unlikely, a deal seems unlikely to emerge from current talks and the Pound will remain under pressure.

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