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Pound-to-Canadian-Dollar Rate Forecasts Downgraded at BMO 

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- BMO forecasts downgraded amid CAD strength, GBP weakness.

- CAD capitalises on US yield retreat as politics weigh on the GBP.

- GBPCAD faces losses before end-June and heading into year-end.

The Pound faces a months-long period of confinement to its current depressed levels against the Canadian Dollar, according to the latest forecasts from the Toronto-headquartered BMO Capital Markets, which have been downgraded due to a strong performance from the Loonie in recent months. 

BMO Capital Markets, Canada's fourth largest lender, has upgraded some of its forecasts for the Canadian Dollar because of the Loonie's strong performance over the last month which has seen the currency benefit from strong economic data as well as a downturn in U.S. Dollar exchange rates. 

Canada's currency is still the best performer in the G10 league table for 2019 after having knocked Pound Sterling off its perch back in May. Now the British currency's fortune is going from bad to worse and the Canadian unit is holding its own in a market that's undergoing a regime change. 

"We have moved our 1M view down to 1.32 due to the collapsing interest rate differential and rising pressure on long-USDCAD positions," says Greg Anderson, head of FX strategy at BMO, in a note to clients. "Event risk hedging prior to October’s Canadian election is likely to be CAD-negative in the July September period, although we think the election could flip and became a CAD-positive factor by the time we get to October."

Above: U.S-Canadian 2-year yield gap, alongside USD/CAD (black line, left axis) at daily intervals.

Statistics Canada data showed last week that Canadians continued to put their hands in their pockets in order to spend on the High Street in April, while other figures have also recently shown the unemployment rate falling to a fresh record low while inflation has picked up sharply

The combination of those figures suggest the economy is still doing well and could mean the Bank of Canada (BoC) would find it difficult to justify cutting its interest rate in the near future, which is important for markets given the current international backdrop. 

Canada's currency is riding high and its economy motoring along at the same time that financial markets are betting heavily the U.S. Federal Reserve will cut its interest rate as many as three times before the year is out. 

That led Canadian government bond yields to rise and U.S yields to fall so that the additional return earned by investors who buy bonds in America rather than Canada has now reduced notably since the beginning of May. 

This has dragged the USD/CAD rate lower and pushed up most other Canadian exchange rates including the Pound-to-Canadian-Dollar rate. BMO's Anderson says these factors could continue supporting the Loonie for a while yet. 

"USDCAD is far out of alignment with its 2Y interest rate differential (see chart). Even if that interest rate differential rebounds a bit, USDCAD would need to come lower to re-establish it previous alignment," Anderson writes. 

Canada's Dollar is one of the few currencies to have capitalised on a deteriorating outlook for the U.S. economy and Federal Reserve interest rate policy, while Pound Sterling has been deprived of the same level of support by the Brexit farce recently seen in the UK parliament and by the ongoing Conservative leadership election. 

Above: BMO Capital Markets graph showing USD/CAD alongside U.S.-Canada yield differential.

The Pound's troubles are not yet over, according to Anderson's European counterpart Stephen Gallo, who projects more losses for Sterling over the coming months as the UK heads for a 'no deal' Brexit or for a general election that risks handing 10 Downing Street to an openly Marxist opposition party. 

"We think the balance of domestic & international factors favours a move to 1.23 in GBPUSD over the coming 3M. Our longstanding position has been that some combination of a “no deal Brexit” and/or early elections will continue to weigh on the GBP, so we continue to expect a political risk discount to remain embedded in the currency as far out as the 6M part of the curve," Gallo writes, in a May review of the Pound Sterling outlook. 

Meanwhile, Canada's Loonie could see further gains this year, especially if the opposition Conservative Party tables a pro-business manifesto that includes tax cuts and solutions designed to make the country more competitive. 

Canada's economy has lost competitiveness in the wake of President Donald Trump's mammoth programme of tax cuts, which almost cut the corporate tax rate in half while also handing a sizeable chunk of wages and salaries back to the average worker. 

With the U.S. being Canada's largest trade partner while located just across the border, not to mention inside of the tariff-busting North American Free Trade area, some economists have feared that Canada could lose out over the long term if its tax policies do not keep pace with those across the Southern border. 

"An average of the 8 opinion polls taken in June regarding October's Canadian election has the Conservative Party 5% ahead. The Conservatives have yet to release a detailed economic platform, but that should happen at some stage. IF it involves tax cuts, and if the final debate regards competing ‘competitiveness’ plans, CAD could rally hard," Anderson says. 

 

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.

BMO forecasts the Pound-to-Canadian-Dollar rate will fall from 1.68 Monday to 1.65 by the end of June and that it will remain around that level until the final quarter of the year when it is expected to drop further, to 1.64.

The September-to-December forecasts are downgrades from earlier projections of 1.68 and 1.72 respectively.

The USD/CAD rate, on the other hand, is projected to end the June month at its current level of 1.32 before rising to 1.34 in September, ahead of the October election, and then falling back to 1.32. The exchange rate is forecast to fall to 1.31 by March 2020 and 1.30 by June 2020. 

 

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