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The Pound to Canadian Dollar exchange rate is running at levels far ahead of where it should be according to new research from a prominent Canadian bank.

Canadian Imperial Bank of Commerce (CIBC) - one of Canada's 'big five' banks - says the Canadian Dollar will ultimately rediscover support as investors realise rate cuts in Canada are still some way off.

"While the market is currently pricing in what looks like a premature easing in Fed policy this year, it's also understating the Bank of Canada's willingness to let several weak quarters go by before it will be ready to ease, a development we don't expect to see until 2024," says Katherine Judge, Director & Senior Economist at CIBC Capital Markets.

The market currently sees at least 25 basis points of rate cuts from the BoC by December of this year with cuts accelerating through early 2024.

But pricing shows the odds of a cut start to build from the third quarter onwards.

Above: The outlook for Canadian interest rates is skewed lower, something that has weighed on CAD of late. Image courtesy of ANZ.

Expectations amongst investors for cuts increased on April 18 following the release of some softer-than-expected inflation figures that suggested the BoC was right to recently pause its rate hiking cycle.

The Candian Dollar retreated against the majority of its major peers after Canadian inflation fell from 5.2% to 4.3% year-on-year in March.

The GBP/CAD exchange rate rose a third of a per cent on the day and has followed this up with another half per cent gain to 1.6724 at the time of writing.

But CIBC sees the exchange rate ending the second quarter at 1.66, according to its latest monthly foreign exchange forecast update.

The pair is expected to then retreat further to 1.64 by the end of the third quarter and before ending 2023 at 1.65.

The ability of GBP/CAD to trade above its point forecasts is also explained by an improvement in UK macro sentiment which has benefitted from better-than-expected economic data, particularly on the consumer side, says CIBC strategist Jeremy Stretch.

"Positive data surprises, with the economic surprise index testing year-to-date highs on gains in GfK consumer confidence, point towards a more supportive GBP backdrop," he adds.

Nevertheless, despite the rebound in UK economic data, CIBC is wary of the market proving too aggressive regarding the peak in the Bank of England's terminal rate assumptions.

Markets are currently fully priced for another 25 basis point rate hike in May, with a further 25bp move expected before the peak in Bank Rate is achieved.

Expectations for further hikes were bolstered this week by stronger-than-expected UK wage data and inflation data that showed prices continue to rise at double-digit rates in March.

But economists say UK CPI inflation can fall quickly from here as base effects are set to provide some "powerful inflation relief" into early Q2.

This could scrub some of the Bank of England rate hike expectations from the board and set in motion a softer performance by the Pound into mid-year.

"Moreover, the lagged effects of past BoE tightening have yet to work through the system, and the BoE will have to take stock of those impacts in the wake of 11 straight increases.

As a result, the market's current terminal rate assumptions, towards 4.60%, are too high. We expect a correction in expectations," says Stretch.