GBP/CAD risking slippage back below 1.71Weighed down by softer USD, oil price rallyCAD eyes CA inflation data, BoC implicationsUK CPI data to offer insight on BoE outlook

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The Pound to Canadian Dollar exchange rate recovery has stalled, leaving Sterling at risk of a further setback this week when it and the Loonie will navigate a raft of key economic figures including December's inflation data.

Canada’s Dollar was one of the better performing major currencies last week after benefitting from what appeared to be a wave of profit-taking that took wind from the U.S. Dollar’s sails and may have helped to lift the West Texas Intermediate benchmark for crude oil back above $80 per barrel.

While the Pound also benefited from the softer U.S. Dollar and what many analysts perceived as a paring back of bearish wagers against the main Sterling exchange rate GBP/USD, it was unable to avoid ceding ground to a resurgent Canadian Dollar.

The Loonie pushed GBP/CAD beneath 1.72 last week before confining it to a tight range spanning the gap between 1.7082 and 1.7220, the bottom of which could potentially be seen again over the coming days.

Much depends this week on the market’s assessment of any implications for Bank of Canada (BoC) and Bank of England (BoE) interest rate policy stemming from the volley of economic figures due to emerge from the UK and Canada, and most notably the latest inflation figures.

“Domestic data suggest that the economy ended last year on a very robust note and while Omicron will result in a sharp slowdown in activity in Q1, we expect growth will see a snappy pick up in Q2,” says Shaun Osborne, chief FX strategist at Scotiabank, writing in a Friday research briefing.

Above: GBP/CAD shown at daily intervals with selected moving-averages.

Reference rates at publication:

GBP to CAD spot: 1.7140High street bank rates (indicative): 1.6540 - 1.6660Payment specialist rates (indicative: 1.6986 - 1.7020Find out about specialist rates and service, hereSet up an exchange rate alert, hereWhile Canada’s Dollar is likely to pay close attention on Monday to the latest business outlook survey from the Bank of Canada (BoC), the highlight of the week ahead for the Loonie is almost sure to be the release of December’s inflation figures on Wednesday.

“The CPI inflation rate isn’t quite as scary as that stateside, helped by the fact that used cars aren’t included, and by somewhat tamer wage trends thus far. Even so, we’ll be hanging on a thread to stay below 5%,” says Avery Shenfeld, chief economist at CIBC Capital Markets.

CIBC’s Shenfeld looks for Canada’s annual inflation rate to rise from 4.7% to 4.9% for December but the consensus among economists suggests it will rise to only 4.8%, which potentially creates scope for an upside surprise that might be supportive of the Canadian Dollar if it materialises.

If Wednesday’s data does surprise economists' expectations then it could fuel market speculation about a possible interest rate rise from the Bank of Canada (BoC) coming as part of its January monetary policy decision, which hasn’t been priced-in by interest rate markets.

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“USD/CAD may sustainably break below 1.2500 this week. CAD has been supported by strong oil price gains and Bank of Canada (BoC) rate hike expectations,” says Kim Mundy, a senior economist and currency strategist at Commonwealth Bank of Australia.

Financial markets have so far been reluctant to wager on a January rate rise from the BoC because the bank suggested strongly in its December policy decision that a change in borrowing costs was highly unlikely before the second quarter of this year.

But if this week’s CPI data encourages any such speculation then it could come as a headwind for the Pound to Canadian Dollar exchange rate and especially if the resulting price action leads USD/CAD back to or beneath last week’s lows around 1.2450.

“USDCAD might find a bit of a lift after basing around 1.2450 but we rather think upside potential is a bit more limited; solid domestic data next week may bolster BoC expectations a little more and leave markets reluctant to short the CAD too aggressively,” Scotiabank’s Osborne said last week.

Above: USD/CAD shown at daily intervals with Fibonacci retracements of December decline indicating possible areas of technical resistance to recovery.

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GBP/CAD tends to closely reflect the relative performances of GBP/USD and USD/CAD, the latter of which could potentially pull Sterling back toward January’s low at 1.7082 over the coming days in the event of a fresh decline back toward 1.2050.

Such price action in USD/CAD would leave the main Sterling exchange rate GBP/USD with a lot of heavy lifting to do in order to keep GBP/CAD afloat.

“December CPI could provide some support if it is stronger than expected (Wed). Interest rate markets are currently pricing an 80%+ chance of a 25bp rate hike by the Bank of England (BoE) on 3 February. A quicker pace of inflation could see pricing move closer to 100%,” says CBA’s Mundy.

In the event of another strong performance from the Loonie, the Pound to Canadian Dollar rate would be dependent for support on the UK’s inflation data for December, which due out mere hours ahead of Canada’s this Wednesday.

The data is widely expected to show annual price growth climbing from 5.1% to a new decade high of 5.2% and could potentially lead the market to bet more confidently that another interest rate rise is likely to be announced by the Bank of England (BoE) in February as opposed to March.

Pricing in the overnight-indexed-swap market indicated on Monday that investors see the BoE as most likely to wait until March 17 before raising Bank Rate for a second time, although this could potentially change if inflation pressures were shown to have escalated further ahead of year-end.