Pound Tipped to Fall against Canadian Dollar by Macro Hive

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The Pound is tipped to retreat from near multi-year highs against the Canadian Dollar by analysts at Macro Hive, who think the UK currency is expensive relative to fundamentals.

Richard Jones, a strategist at Macro Hive, says "fading GBP strength is attractive from a technical, mean-reversion perspective."

The call comes ahead of the Bank of England's June interest rate policy decision and the release of inflation numbers for May, which should show inflation in the UK has fallen closer to the 2.0% target.

Macro Hive, an independent research and market strategy provider, thinks UK bond yields can extend a recent decline, helped by these event risks.

"We think the recent downward momentum for UK short-end yields can continue and reiterate our initial target of 4% outlined last month," says Jones. "We think lower UK short-end yields will weaken the pound, and we express this view via GBP/CAD."

Foreign exchange markets are highly sensitive to shifts in global bond yields, with capital flowing to where yields are highest. The yield on UK government bonds (gilts) is amongst the highest in the G10 thanks to the Bank of England raising interest rates more than many of its peers.

This has made the Pound the second-best G10 performer in 2023 and 2024.

Risks to this outperformance would occur if UK yields fall faster relative to elsewhere.

Above: GBP/CAD fell sharply last Friday, unwinding overbought conditions (see RSI above 70 in below panel). Track GBP/CAD with your own alerts, find out more here.

"If UK yields fall further as we expect, GBP should also trade lower. Our favoured pair to express this is GBP/CAD," says Jones.

Macro Hive thinks the Bank of England will cut by more than the market is expecting in 2024, owing to the deteriorating labour market, which will help bring inflation levels down.

Heading into Thursday's Bank of England, "we expect more MPC dovishness next week," says Jones. "This will weigh on UK short-end yields."

Jones' colleague at Macro Hive, Ben Ford, recently outlined four reasons why he thinks GBP/CAD is likely to trade lower:

1. GBP/CAD long positioning is crowded and due an unwind.
2. Two-year rate differentials in favour of GBP are stretched and due an unwind.
3. Positive data surprises in the UK are unsustainable.
4. The oil market could tighten in coming months, which will be CAD positive.

"For these reasons, we think GBP/CAD will trade lower from the current level," says Jones.