Canadian Dollar Forecasts Upgraded at Goldman Sachs, All Eyes on BoC Decision

- GBP/CAD follows tight ranges
- BoC could sound cautious tone on employment situation
- Could prompt CAD weakness
- But Goldman Sachs see reward in owning CAD

Canadian Dollar outlook

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Foreign exchange analysts at Goldman Sachs have raised forecasts for the Canadian Dollar, saying they expect limited risks from this week's Bank of Canada meeting and that they see good "risk reward" in owning the currency.

In a weekly currency briefing to clients, analysts at the Wall Street bank say there are three factors guiding their more bullish stance on the currency:

1) Rising oil prices
2) A helpful basket of Canadian exports
3) Canada’s real effective exchange rate is not strong enough to warrant a pushback from the Bank of Canada (BoC)

The call comes as the Canadian Dollar retains its status as the best performing major currency in the G10 grouping of the world's largest freely-traded currencies.

The currency has found investor support thanks to Canada's rapid vaccination rollout that has left more Canadian's having received a first dose of the vaccine than is the case south of the border:

Canadian vaccinations overtake the US and UK

Support for the currency also comes courtesy of the BoC which said in April it is willing to reduce the scale of support it is offering the economy in light of the economic recovery that is underway.

The decision prompted a strong bout of Canadian Dollar demand, but there is a risk that the supportive BoC narrative has now run its course, leaving the currency looking elsewhere for appreciation drivers.

"The June BoC Announcement should be a relatively quiet affair. Despite a weaker than expected Q1, we look for the Bank to argue that the outlook is unfolding roughly in-line with their April forecast. We expect the forward-looking passage to signal 2022H2 rate hikes, and we do not expect any change in QE at this meeting," says Richard Kelly Head of Global Strategy at TD Securities.

Foreign exchange markets are presently focussed on how fast the world's largest central banks are withdrawing stimulus measures, with those currencies belonging to central banks that are reducing support finding themselves better supported than those belonging to central banks that are content to sit on unchanged policy settings.

The BoC is leading the pack on this measure thanks to the April decision to reduce weekly asset purchases under its quantitative easing programme from C$4BN to C$3BN.

There are however risks that the BoC could strike a cautious tone on the outlook in the wake of some softer-than-expected labour market statistics out last week.

The Canadian Dollar fell against the Pound, Euro and other currencies last week after Canada reported softer-than-expected employment data that revealed the country lost 68.0K jobs in May.

If the BoC opts to strike a cautious tone on the labour market the Canadian Dollar could find itself coming under some short-term pressures.

At the head of the new week the Pound-to-Canadian Dollar exchange rate is seen at 1.7085, putting it in the middle of its May-June range.

So intact is this range it is unlikely that a close above 1.7150 is likely in the near-term, while a close below 1.7050 is equally remote.

GBP to CAD has fallen into an uninspired range

Above: GBP/CAD has fallen into an uninspired range over recent weeks.

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On the basis that Goldman Sachs anticipate the Canadian Dollar will likely remain well supported going forward GBP/CAD could subsequently struggle to establish meaningful upside.

Goldman Sachs last week lowered their forecasts for USD/CAD to 1.19, 1.17 and 1.15 in 3, 6 and 12 months (from 1.21, 1.20 and 1.20 previously).

"Further oil price appreciation as economic demand recovers faster than supply should continue to provide the key pillar of support for CAD," says Zach Pandl, Economist at Goldman Sachs.

Furthermore, Pandl says Canadian exports are particularly geared towards rates-sensitive parts of the US economy that should continue to expand.

The U.S. economy is growing rapidly courtesy of the country's exit from Covid-19 restrictions amidst falling case rates and rising vaccinations.

But the extra sauce powering the rebound appears to be the extraordinary stimulus being provided by the U.S. Federal Reserve and the government of Joe Biden.

Pandl meanwhile argues Canada’s real effective exchange rate is still well below levels that would warrant a change in the policy outlook held by the BoC.

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Currency value matters to the BoC's Governor Tiff Macklem who on May 14 warned:

"If it moves much further, that could become more of a headwind on our export projections... that could have a material impact on our outlook and it’s something we’d have to take into account in our setting of monetary policy."

The rise in the Canadian Dollar presents a headwind to domestic growth if it lowers the earnings of Canadian exporters.

Therefore central bankers are often left to consider their policy initiatives in light of the impact they have on the currency.

Should the BoC warn on Wednesday they are concerned about the value of the Canadian Dollar, it could ease back as it would suggest the BoC is willing to strike a more accommodative stance to quell its advance.

But for now, Goldman Sachs are of the view the value of the currency is not yet high enough to warrant a strong reaction from the BoC.

"While we do not think that these factors warrant a return to “oil supercycle” levels for USD/CAD, we do think there is still good risk-reward in CAD longs as one of the best expressions of the “reopening” and “reflation” themes in G10 FX," says Pandl.

Goldman Sachs say they think that the BoC is more likely to taper asset purchases further at the July meeting when the Bank publishes a new Monetary Policy Report with revised projections, given that policymakers have expressed that the tapering timeline in Canada will be outlook-dependent.

"Furthermore, when the Banks’ projections are updated, we expect that the impact from a stronger CAD will be offset by stronger income projections from higher oil prices," says Pandl.

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