Canadian Dollar Retreats from Sterling after BoC Flip-flop but Big Test Looms This Friday

- GBP/CAD breaks above key resistance level on the charts.

- After BoC sets stage for interest rate flip-flop on Wednesday.

- BoC hints economy must deliver forecasts or rate cut ensured.

- CA data has underperformed of late, curtailing appetite for CAD.

- CIBC, RBC look for April rate cut as TD targets 1.33 in USD/CAD.

- GBP eyes BoE's own rate stance, Friday's data is key to outlook.

- GBP/CAD Spot rate: 1.7296, up 0.12% today

- Indicative bank rates for transfers: 1.6691-1.6812

- Transfer specialist indicative rates: 1.7037-1.7140 >> Get your quote now

The Pound-Canadian Dollar recovery off post-election lows was aided this week by signs of a policy flip-flop from the Bank of Canada (BoC) that could prove a gamechanger for the outlook, but appetite for Sterling will be tested over the coming days so a renewed trend higher is far from assured. 

BoC Governor Stephen Poloz was less sure on Wednesday that Canada will be able to continue standing apart from the crowd after announcing the cash rate would be kept at 1.75% for this month. The BoC's January policy statement began by noting recent tensions between the U.S and Iran before morphing into a kind of mea culpa in which the bank acknowledged it may have been too optimistic in its outlook for the economy back in October. 

Canadian policymakers now see economic growth coming in lower than was previously forecast for the final quarter 2019 and first three months of the current year and although they still look for a pickup in the rate of expansion thereafter, the bank has put markets on notice that a rate cut will follow any signs that the economy is not living up to its forecasts.

"While it kept interest rates unchanged today, and its economic forecast has the skies clear by spring, it conceded that there’s a risk that the sluggish trend could persist, a hint that a rate cut could still be in the offing ahead," says Avery Shenfeld, chief economist at CIBC Capital Markets. "If, as we expect, slow GDP growth prompts softer hiring and a climb in the jobless rate ahead, it will not only be less easy politically to keep rates where they are, but it will also add to downside risks to household confidence."

Above: Pound-Canadian Dollar rate shown at hourly intervals.

Most notably, the BoC has put the onus on the economy to deliver the bank's forecast performance if a rate cut is to be avoided and judging by the market's reaction to the statement, investors appear to be harbouring doubts about whether the economy can do that.

The Canadian Dollar retreated rapidly from a recovering Pound Sterling after the announcement and also ceded ground to what was a softer U.S. Dollar. 

"The Bank is very worried about the state of the Canadian consumer and its potential to prolong this slowdown. That means any data point that gauges retail spending, confidence, etc. (including secondary wealth effects like equities) should have some gamma risk," says Bipan Rai, North American head of FX strategy at CIBC. "Poloz’ message to the market: The rate cut will come when the data misses expectations ‘meaningfully’. That’s it. There will be no cuts due to hypotheticals (like insurance cuts)."

Last year Canadian economic data were much stronger than markets had anticipated from the second quarter onward and also stronger than figures emerging from other comparable economies. That and rising inflation enabled the BoC to leave the cash rate unchanged at 1.75% all year even as other central banks cut rates amid a mounting global economic slowdown.

BoC rate policy made the Loonie the developed world's highest yielding and best performing currency for 2019 but Wednesday's statement has seen investors grow less certain the bank will be able to avoid a cut this year. 

Above: Pound-Canadian Dollar rate shown at 4-hour intervals.

The overnight-index-swap (OIS) implied cash rate for April 15 fell from 1.68% before the statement to 1.62% by Thursday morning, prompting the Loonie weaken and enabling the Pound-Canadian Dollar rate to bounce sharply off a key support level around 1.70 to be quoted at 1.7274. 

"The BoC is also concerned that Canada's economy is being more negatively impacted by global headwinds than previously thought. Even with positive trade developments and signs that the global economy is stabilizing, "a high degree of uncertainty" remains," says Josh Nye, a senior economist at RBC Capital Markets. "Tolerance for sub-trend growth is likely to be limited. Today's statement makes us more comfortable with our call for a rate cut in April."

Nye is not alone in looking for an April rate cut because Shenfeld and the CIBC team are also tipping a move at that time too.

Canadian bond yields are proving a draw for investors as a result of the BoC's rate policy and the currency has risen in response but the economy is now slowing rapidly and it's no longer certain that above-target inflation will be enough to prevent the BoC from cutting rates. That could mean there's plenty more upside to come for the Pound-Canadian Dollar rate if the Bank of England decides to eschew its own interest rate cut on Thursday 30, January. 

Pound Sterling has been in retreat from post-election highs against the Loonie since mid-December but selling pressure increased last week when Office for National Statistics data showed the economy contracting -0.3% in November and growing far beneath its inflation-producing rate in the 12 months to that point. And with inflation subsequently revealed to have fallen to 1.3% in December, taking it further beneath the 2% target, markets are all but certain a rate cut will come at month-end. 

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

"The consolidation range trade retains a mild, downwards tilt and the GBP clearly reversed from the late 2019 high in a meaningfully bearish way—which suggests to us that the correction still has further to run. We note resistance defined by the 40-day MA at 1.7163 currently and feel the GBP will need to break well through here in order to avert more weakness," says Juan Manuel Herrera, a strategist at Scotiabank in a Tuesday research note. 

Friday's IHS Markit PMI surveys and Wednesday 29, January's autumn forecast statement from HM Treasury could easily turn things around for Pound Sterling, which has now broken above a resistance level on the charts that had previously barred its path higher against the Canadian Dollar. The BoE has indicated that  January pick up in the economy could be enough to avert a rate cut and Friday's flash PMI surveys could provide evidence of exactly that.

Meanwhile, next week's budget preview is expected to yield details of a large fiscal stimulus that could be a gamechanger for the UK economic, interest rate and currency outlooks. The OIS-implied Bank Rate for the end of January reached a new low of 0.54% on Wednesday, far beneath the current 0.75% rate and only a fraction above the 0.50% that would prevail after a typical 25 basis point cut. Any reversal of that pricing would likely lead Sterling to rise. 

"The CAD took a turn for the worse following the BOC's dovish pivot," says Mazen Issa, a strategist at TD Securities. "Thus far, data in November has fared on the weak side and disappointment on retail sales later this week could be the final nail in the coffin. As far as we are concerned however, we remain comfortable in targeting 1.33 in USDCAD." 

Above: USD/CAD rate shown at daily intervals.