GBP/CAD supported at 1.6850 short-termRecovery attempts could fade around 1.71Canadian GDP data, Fed decision in focus

Image © Adobe Stock

The Pound to Canadian Dollar exchange rate has reversed sharply from some of its highest levels for more than a year and entered the new week with a nine-month uptrend hanging in the balance on the charts with the outlook hinged on whether it can hold a nearby technical support in the 1.6850 area.

Canadian Dollars were bought widely last week alongside the U.S. Dollar with one of the Loonie's largest advances coming in relation to an underperforming Pound that has so far been unable to recover its poise since UK inflation was said to have fallen for the first time since April last week.

GBP/CAD's losses came after Canadian inflation itself also continued to fall while coming closer to the Bank of Canada (BoC) target than the rates prevailing in the UK last month in what might have been more a symptom of global market risk aversion and investor appetite for North American currencies in general.

"Sterling has already given back more than half of the late June/early July gains and a deeper retracement towards the 1.67/1.68 zone now looks quite likely (daily trend support at 1.6789 currently). Note the daily DMI signal is poised to turn negative for the GBP," says Shaun Osbourne, chief FX strategist at Scotiabank.

"USDCAD trends remain bearish from a longer run point of view following the USD’s break under long run trend support (1.3350 on the weekly chart). USDCAD will have to gain through 1.3385/90 to show more obvious technical strength at this point," he writes in a review of the Canadian Dollar charts last week.

Above: Pound to Canadian Dollar rate shown at daily intervals alongside USD/CAD and spread or gap between 02-year UK and Canada government bond yields.

While the BoC's more refined measures of core inflation in Canada edged higher for June last week, both the official measure and its core inflation derivative fell further and closer to 3.2% and 2.8% respectively, placing both within arm's reach of the 2% target and keeping implied market expectations for the cash rate stable.

"Over the past week, the deceleration in price pressures in several economies has tilted things towards a new disinflation zeitgeist in the market," writes Bipan Rai, North American head of FX strategy at CIBC Capital Markets, in a note last week.

"That also works to support the current central bank spin – that the proximity to terminal policy rates is close at hand as tighter financial conditions continue to work to curb demand in the coming quarters," he adds.

Receding inflation and moderating economic activity evidenced by last Friday's softer-than-expected retail sales report for June and a host of indicators including several months of ebbing employment growth and more limited GDP growth in recent months have all helped to dampen expectations for interest rates over the remainder of the year.

Financial markets were pricing in only around a 50% probability on Monday of a further increase in the cash rate, from its current 5% level, being announced later this year though these odds will be sensitive to Canadian economic figures emerging up ahead including GDP data for May due out on Friday.

Above: Pound to Canadian Dollar rate shown at daily intervals with Fibonacci retracements of second quarter rally and selected moving averages indicating possible areas of technical support for Sterling.

"The steady moderation in Canadian inflation (thus far) is ultimately a positive medium-term development for the macro backdrop and foreign investor interest in CAD assets," says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

"However, with the BoC likely finished hiking and major European central banks still lifting their policy rates, near-term CAD strength against the major European currencies will be limited – at least until colder weather arrives in Europe," he adds on Monday.

Canadian GDP data is the highlight of week for GBP/CAD and what is a quiet period in the UK economic calendar though minutes of the July Bank of Canada monetary policy meeting are out on Wednesday and are also likely to garner attention from the market.

The Loonie may also be sensitive to the U.S. Dollar's response to Wednesday's Federal Reserve (Fed) interest rate decision, which would be a negative influence on GBP/CAD if it leads the greenback to strengthen and vice versa, if recent correlations hold.

"The end of the Fed’s hiking cycle will help to soften the USD, and further signs of inflation ebbing will also matter – as we have already witnessed. But to really see the USD’s range bound behaviour finish and renewed weakness emerge, stronger evidence that a softer landing for global growth, including the US economy, must also materialise," writes Paul Mackel, global head of FX research at HSBC, in a July forecast review.

Above: Pound to Canadian Dollar rate shown at weekly intervals with Fibonacci retracements of selected downtrends indicating possible areas of technical resistance for Sterling. Selected moving averages denote possible support and/or resistance.