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Scotiabank sees Canadian dollar resilience holding, leaving the pound's rally against it vulnerable.
The pound-to-Canadian dollar exchange rate extends its September rally to 1.8819 on Wednesday, pressing into resistance that has capped every rally since early July.
The pound's gains have come against a Canadian dollar that is holding up well against its peers, which argues the move is to a great degree sterling-driven and exposed.
"The CAD is soft, extending its latest pullback while showing modest gains relative to its G10 peers allowing it to strengthen on the crosses," says a daily note from Scotiabank's FX strategy team.
Scotiabank groups the Canadian dollar with the yen and the pound as the G10 currencies offering "lesser losses" in a risk-averse market, while the Norwegian krone, Australian and New Zealand dollars and Swedish krona underperform.
CAD Resilience Tipped to Continue
"The Canadian dollar (CAD) has staged clear recovery since late June, showing impressive resilience in the context of intensified trade policy uncertainty and a significant deterioration in the US-Canada relationship," says Eric Theoret, FX Strategist at Scotiabank, in the bank's monthly FX Outlook.
A US ban on around $1bn of Canadian imports, targeting alcohol and dairy, has since taken effect, which Scotiabank describes as a minor drag on sentiment.
Above: GBP/CAD at daily intervals, with the 21-day (blue) and 100-day (red) moving averages and the downtrend from July's high.
Scotiabank's medium-term case for the Canadian dollar rests on the Bank of Canada, which it expects to begin a hiking cycle by late this year, extending into next, with 75 basis points of tightening in total.
The BoC removed its guidance that the current policy rate "remains appropriate" at its September meeting and warned that upside risks to inflation had increased.
"You don't drop a key forward guidance sentence, warn on inflation risks, use language that intimates a move conditioned around fresh forecasts, then issue said forecasts, only to whiff," says Derek Holt, Head of Capital Markets Economics at Scotiabank.
Holt points to traditional core inflation running above 3% on an annualised monthly basis for three straight months.
A move by markets towards pricing that path would narrow rate spreads in the Canadian dollar's favour.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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Talk to a specialistThe Spread Picture Is Turning
The recent widening in US-Canada spreads, which Scotiabank cites as a headwind for the currency, has been driven by the US side, as markets priced further Federal Reserve hikes.
That driver has faded over the past 24 hours after New York Fed President John Williams said on Tuesday there is "no need for urgency" for another hike, and US two-year yields fell 5 basis points in response.
For the pound-to-Canadian dollar rate, the relevant spread is UK-Canada, and it is exposed from the UK side too.
UK money markets price a near-certain Bank of England hike in November, with several more to follow.
Commonwealth Bank of Australia, Berenberg and OCBC all expect the Bank of England to deliver just one.
A Bank of England that delivers less than priced, alongside a Bank of Canada that begins hiking, would shift the UK-Canada spread towards the Canadian dollar from both ends.
That is a case for fading the pound's gains.
Undervalued on Scotiabank's Model
Scotiabank's fair value estimate for USD/CAD stands at 1.4099, against a spot rate near 1.42, leaving the Canadian dollar cheap relative to rate spreads.
"We believe a considerable amount of bad news is already priced into the CAD at current levels," says Shaun Osborne, Chief FX Strategist at Scotiabank.
Scotiabank targets USD/CAD at 1.37 by year-end and 1.33 by the end of 2027.
Paired with its pound-to-dollar forecasts, that points to a pound-to-Canadian dollar rate near 1.8769 at year-end and near 1.8487 by the end of 2027.
The pound's support has limits of its own, with gilt yields rising during Prime Minister Andy Burnham's conference speech on Tuesday as he set out spending commitments due to be costed at the 28 October budget.
Daniella Arcadipane, Senior Currency Specialist at Indigo
Moving a life-changing sum abroad? You won’t be doing it alone.
One specialist explains every step in plain English and stays with it until the money lands. FCA authorised, FRN 594433.
Talk to a specialist
