Above: BoC Governor Poloz. Image © Bank of Canada, Reproduced Under CC Licensing

- GBP/CAD sells off due to interest rate hike

- Bank of Canada becomes more optimistic

- Easing trade and strong economy contribute

Downside risks are building for the Pound-to-Canadian Dollar exchange rate after the Bank of Canada (BoC) said they were probably going to raise interest rates at a more aggressive pace than previously expected.

The bullish talk from the central bank ignited a rally in the Canadian unit as it suggests interest rates in Canada will rise more rapidly than in the UK, and this will lead investors to favour Canada as a place deposit their capital which in turn will increase demand for CAD.

The Pound-Canadian Dollar exchange rate recorded a multi-week low at 1.2833 in response to the move; it is currently quoted at 1.2880.

The resulting sharp decline in the GBP/CAD exchange rate - which indicates the number of Canadian Dollars one Pound buys - suggests more downside is on the horizon for the exchange rate.

Canadian lender Scotiabank are eyeing a potential downside target of 1.66 (from current 1.6780-90s).

“We think downside risks are building for the GBP/CAD quite materially now and we look for major support at 1.66 to come under pressure in the next week or two,” says Shaun Osborne, chief FX strategist at Scotiabank in Toronto.

The decline in Sterling-Loonie came after the Canadian Dollar was propelled higher by the BoC withdrawing a phrase from its forward guidance that said future rate hikes would be “gradual” – and suggesting instead that a more aggressive approach would now be adopted from now on.

The central bank also added that it was planning to raise interest rates to the “neutral rate” or ‘just right’, equilibrium level, where it is neither stimulative or depressive of growth.

The neutral rate ss thought to be between 2.5-3.5% by the BoC’s own estimations. The current base interest rate is 1.75%, so there is at least 0.75% more to be added to reach ‘neutral’, which translates into three future probable 0.25% hikes.

The BoC was upbeat about both the global and domestic economy in its statement.

It said the new USMCA trade pact, will reduce an important source of uncertainty that has been holding back business investment in Canada.

Elias Haddad, senior currency strategist at Commonwealth Bank of Australia, forecasts multiple rate hikes from the BoC in the near future, to a high watermark of 3.0% in June 2020.

On this basis, "CAD can continue to outperform," says the analyst.

“Underlying CPI inflation (average of common, median and trim CPI) is expected to remain sticky near the middle of the BoC’s 1-3% target because Canada’s economy is operating close to full capacity. The BoC estimates Canada’s output gap in a range of just -0.5% to +0.5%. Consequently, we have revised our BoC interest rate forecast,” says Haddad.

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