GBP/CAD supported above 1.63 & may be bottomingCorrective rally possible if BoC goes steady with ratesAfter market assigns high probability of 0.5% increaseStandard step could see USD/CAD & GBP/CAD rally

The Bank of Canada, Ottawa. Image reproduced under CC licensing conditions

The Pound to Canadian Dollar exchange rate may be in the process of bottoming out and would be likely to make a further attempt at a corrective recovery this week if the Bank of Canada (BoC) leaves a ‘hawkish’ market hanging by raising its interest rate at the same steady pace as before.

Sterling exchange rates opened the new week stronger with GBP/CAD attempting to lift above the round number of 1.64 but still around 100 points below where it might be likely to trade if the BoC lifts its cash rate by 0.25% to 0.75% in Wednesday’s April monetary policy decision.

The Pound to Canadian Dollar rate could potentially come close to the 1.65 handle this week if the BoC stays a steady course as this would surprise financial markets that have wagered confidently that there’s a high probability of a larger change in the cash rate than that.

“We expect the policy statement, MPR and Governor Macklem’s press conference to reflect a hawkish undertone which will support the CAD broadly. But there is a risk that either a) policy makers fail to deliver what is already priced in for next week or b) do not prove sufficiently hawkish guidance to justify what the swaps curve have priced in for the coming months,” says Shaun Osborne, chief FX strategist at Scotiabank.

Financial markets, analysts and economists collectively anticipate that the BoC will instead lift the cash rate by a larger-than-usual increment of 0.50%, taking the benchmark for borrowing costs up to 1% in an outcome that would potentially come as a burden for GBP/CAD.

Above: Pound to Canadian Dollar rate shown at daily intervals with Fibonacci retracements of learly March decline indicating possible areas of short-term technical resistance for Sterling and featured alongside spread - or gap - between 02-year UK and Canadian government bond yields. Click image for closer inspection.

“It’s a given that stern language has to accompany a move to raise rates by a half percent, in order to let indebted Canadians know why that pain is necessary,” says Avery Shenfeld, chief economist at CIBC Capital Markets.

Many economists also suspect the BoC will announce the beginning of the process known as quantitative tightening, which would have upside implications for Canadian government bond yields and for the Loonie, which also implies that Wednesday will be a headwind for GBP/CAD.

However, it could be that the risk is of a second 0.25% increase that would take the cash rate to only 0.75%, which would be something of an upset for the market and almost sure to lift GBP/CAD and USD/CAD sharply on the day.

“The central bank will likely take some comfort from the fact that businesses expect inflation to return to the 2% target after the next couple of years. But current price growth is still running too firm to ignore,” says Nathan Janzen, a senior economist at RBC Capital Markets.

(Set your FX rate alert, here).

“Easing off the monetary policy accelerator—and getting interest rates back to a more ‘neutral’ level that won’t add to or subtract from longer-run inflation pressures—is the most likely path near-term,” Janzen also said on Monday.

All of this is after Governor Tiff Macklem told the CFA Society of Toronto last month that the BoC would lift the cash rate in a “deliberate and careful way, being mindful of the impacts and monitoring the effects carefully,” in the months ahead.

Much depends on what the BoC makes of recent favourable developments in employment s well as the ongoing increases in inflation as these could each encourage the bank to raise rates at a faster pace than it did back in March.

Any decision by the BoC to move at an unchanged pace would risk fueling the nascent upturn in the all-important USD/CAD exchange rate, which has been supportive of GBP/CAD in recent trading including through the surge in U.S. government bond yields.

Above: USD/CAD shown at daily intervals with selected moving-averages and Fibonacci retracements of March downtrend indicating possible areas of short-term technical resistance. Click image for closer inspection.

“The USDCAD rebound from the 1.24 level mid-week and today’s push above 1.26 puts in a bullish outside range (highlighted, over) on the weekly chart (assuming spot close at or above the 1.2550 area today). Coincidentally, we see similar signals on the AUD and NZD weekly charts, suggesting weakness ahead for these currencies too,” Osborne and colleagues said on Friday.

The U.S. yield rally has placed pressure on many currencies including the Loonie and Sterling as the Federal Reserve makes increasingly clear to that it could move at a faster pace than financial markets have been giving credit for.

Much depends for this week on if the nascent rally in USD/CAD continues as well as on whether GBP/USD is able to hold above 1.30, given that GBP/CAD always tends to closely reflect the relative performances of the two.

“The UK has just released a soft set of data for February, including monthly GDP, industrial production, and trade. Given that we continue to back the dollar over the coming months, we suspect it is just a matter of time before Cable [GBP/USD] breaks down to the 1.2850 area. On a longer-term basis, these are cheap levels for Cable,” says Francesco Pesole, a strategist at ING.

USD/CAD and GBP/CAD will also likely be sensitive this week to the outcome of Tuesday and Wednesday’s inflation figures from the U.S. and UK, which might not be quite the stimulus for the Pound as they have been in the past.

This is due to uncertainty over the extent to which the Bank of England (BoE) would respond to rising inflation by raising Bank Rate in the near future, an uncertainty that has grown recently and which could leave the Pound struggling to capitalise on any upside inflation surprise this week.