The Loonie's strength could see the BoC becoming Fed-dependent and give sterling some breathing space after a crushing three-months.

Canada’s currency, affectionately known as the loonie, has risen sharply against the pound sterling in recent months, after the BoC followed in the footsteps of the Federal Reserve and called time on its own post-crisis era of ultra-low interest rates.

In a widely expected move, the central bank raised its benchmark interest rate in July, from 0.50% to 0.75%, marking its first upward move for more than seven years and leading markets to speculate on the prospect of further action to come during the months ahead.

“After using a pause in September to signal a go-slow approach, Governor Poloz might be willing to fly solo with a rate hike in October, giving the loonie a moment in the sun,” says Royce Mendes, an economist at CIBC.

The go-slow approach from the BoC could help the pound to Canadian dollar exchange rate, which has fallen more than 8% in the last three months, to find a floor. Sterling was changing hands at 1.6080 during noon trading in London on Wednesday, August 23.

Britain's currency could draw an added boost against the loony in October too, even if the BoC hikes, given that the Canadian central bank may then have to sit on its hands until the Federal Reserve is able to pull away in front of it again.

“With housing likely to slow, there’s a greater need for exports and related capital spending to carry some weight in GDP growth. As a result, given the link between interest differentials and the exchange rate, the Bank of Canada is not only going to be “data dependent, but also “Fed-dependent,” says Mendes.

CIBC has forecast that the pound to Canadian dollar exchange rate will rise to more than 5% by the end of the fourth-quarter, touching 1.7000 before the year is out.

That is without much help from sterling fundamentals, as the economics team remains uninspired by the outlook for the U.K. currency.

“The BoE has indicated that markets may be underpricing the risk of rate hikes. But, even despite an expected bout of currency-related inflation set for the coming months, we’ll need to see more evidence of improvements in other indicators like real incomes before that risk comes into sharper relief,” Mendes says.

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