- GBP/CAD at risk of fall to all-time low near 1.4090 post-BoE decision
- BoE could hit Bank Rate ball out of park but GBP still risks a drubbing
- Negative real yields & UK’s deficit funding considerations likely drivers
- Possible top for Fed cycle could lift CAD & amplify GBP/CAD's losses
- Canadian CPI data also in focus with uncertain implications for Loonie
Image © Adobe Stock
The Pound to Canadian Dollar exchange rate has shown signs of stabilising of late but may now be on the cusp of lurch toward all-time lows if the author is right about how the market might be likely to respond to any exceptionally large interest rate rise from Bank of England (BoE) this Thursday.
Sterling edged higher against the Canadian Dollar to open a holiday-shortened week and remained comfortably above the 12-year lows reached almost a fortnight previously although there is a risk it could be seen falling heavily if the BoE hits the Bank Rate ball out of the park on Thursday.
There is reason for thinking it could too including a recent turn higher in core inflation, the BoE's latest Inflation Attitudes Survey and the new UK Prime Minister's plan to freeze or cap household energy bills through public subsidy, which could be viewed by policymakers as a medium-term inflation risk.
"If the BoE adopts a notably slower pace of rate hikes than its G7 peers or pauses the hiking cycle earlier than its peers, the GBP will probably fall quite sharply," says Stephen Gallo, European head of FX stratetgy at BMO Capital Markets, who sees Sterling falling throughout the next one-to-three months.
Many economists expect the BoE to lift Bank Rate by either 0.50% or 0.75% on Thursday while analysts have generally contemplated how far Sterling might fall if the BoE does too little to satisfy the market this week with few asking what the market response would be if the BoE acts more aggressively than anticipated.
This may have been demonstrated already in August when the BoE raised Bank Rate by 0.5% to 1.75% only for Sterling to then fall widely in the wake of the decision, which suggests at risk of heavy losses if the BoE instead goes far further than financial markets expect.
That is potentially relevant because the author suspects the BoE is likely to lift Bank Rate by at least +125 basis points to 3%, which could stoke investor concerns about the economy but would not improve deeply negative inflation-adjusted UK government bond yields by much.
Negative 'real' yields have been widely cited for the Pound's recent losses while some suggest Prime Minister Liz Truss's energy bill initiative may also be at play as it's likely to add significantly to the national debt just as the BoE begins selling the bonds acquired under its quantitative easing programmes.
"A new fiscal risk is emerging. The UK is set to fund around GBP 150bn worth of spending across energy price support for households and businesses combined with broad tax cuts. Crucially the funding is set to be entirely via gilt issuance," writes Jamie Fahey, a macro strategist at CitiFX, in a recent forecast review.
"Typically large fiscal issuance has come in times of crisis, and QE has been the backstop. Now, the opposite is true. Concerns around who will absorb this issuance may lead to foreigners demanding lower prices, which can come from either gilts or FX weakening. This is a trend we have seen already," he added.
All of this is a part of why the author suspects that Thursday's interest rate decision will do no favours for the Pound and that the main Sterling exchange rate, GBP/USD, may be at risk of falling below 1.10 this week and as far as 1.0613, which would have significant indirect implications for GBP/CAD.
GBP/CAD tends to closely reflect the relative performance of Sterling and the Canadian Dollar when each is measured against the U.S. Dollar, and would likely fall toward 1.4090 and all-time lows this week if GBP/USD reaches 1.0613, although losses would be mitigated by any gains in USD/CAD.
"A stronger reading on the average core measures may very well compel some hawkish repricing on the implied BoC terminal rate, but we think it will only serve to exacerbate macro imbalances in the household sector," says Mazen Issa, a senior FX strategist at TD Securities.
"We think a dip in USDCAD will be short-lived and should be faded into 1.3200/30. We are long USDCAD," Issa wrote in a Monday research briefing.
Thursday's BoE decision is the highlight of the week for Sterling, although GBP/CAD may also be responsive to Tuesday's Canadian inflation data, Wednesday's Federal Reserve decision and Friday's Canadian retail sales numbers.
Above: Pound to Canadian Dollar rate shown at monthly intervals alongside USD/CAD.
"The different methodology for calculating the shelter component should allow the overall inflation rate to cool to a still-high 7.2%, even if, as in the US, we don’t yet make progress on food or new vehicle inflation," says Avery Shenfeld, chief economist at CIBC Capital Markets.
"Cheaper gasoline and softer vehicle sales will be key to a big drop in retail sales for July, but that won’t come as a surprise for markets," Shenfeld wrote in a Friday look at the week ahead.
It's not clear what impact the Canadian data will be likely to have on either USD/CAD or GBP/CAD, although Wednesday's Fed decision could effect both with Sterling potentially benefiting initially from any weakness induced in the U.S. Dollar and coming under pressure if the greenback strengthens.
"Evidence of “sticky” inflation in the US reflected in the higher-than-expected core CPI data has pushed markets to consider the risk of a jumbo rate hike. A 3/4-point tightening is well-priced in now and swaps reflect a (roughly) 20% chance that the Fed goes the full point," says Shaun Osborne, chief FX strategist at Scotiabank.
"A strong weekly close for the USD plus bullishly-aligned trend strength oscillators—DMI—on the intraday, daily and weekly charts suggest ongoing upside risks for the USD in the week ahead and limited potential for counter-trend USD corrections," Osborne wrote in a Friday look at the week ahead.