Published: August 23rd, 2023
The Sterling to Canadian Dollar rate rose to a new August high of 1.7039 this week following publication of Canadian inflation numbers for July.
Inflation in Canada had been on a steady decline during an almost unbroken 10-month downtrend. That changed last month when it climbed from 2.7 per cent to 3.2 per cent and plateaued at 3.2 per cent once energy and food costs are discounted. Both figures were north of economist consensus, giving GBP/CAD a boost in the short term.
While bigger than predicted increases in the country’s two official inflation measures triggered the lift, there was more positive news for Ottawa central bankers in terms of what drove inflation upward in July, and in a lowering of average of July price changes, which moved down from 3.7 per cent to 3.6 per cent.
The latter measure is part of a triplet of refined inflation measures that Bank of Canada economists monitor closely, though arguably the most important detail in July's report from StatsCan related to rising mortgage costs, which can be seen as one outcome of an increase in the cash rate. Mortgage cost rises were the number one inflation driver in July.
‘There was another record year-over-year rise in the mortgage interest cost index of 30.6 per cent, which was the top contributor to headline inflation growth,’ Statistics Canada said in a statement accompanying the figures.
When the impact of rising mortgage costs is taken out, Canadian inflation climbed just 2.4 per cent during for the 12-month period ending in July 2023. That is basically level with the BoC's inflation target and suggests that further near-term rises to the bank’s cash rate are off the table for now.
Last July, analysts at Canada’s Desjardins Bank said the Loonie was headed for steady declines in the second half of 2022.
In a mid-year currency market analysis, economists at the bank’s FX Strategy Unit said they expected the global economic outlook to be challenging over the coming months, a backdrop which would work against the Commodity-sensitive Canadian Dollar. Rising interest rates from the Bank of Canada (BoC) were already adding to the headwinds by pressurizing Canadian households already weighed down with high credit card debt.
‘Global recession worries are now impacting the Canadian dollar, which isn't normally seen as a safe haven during times of upheaval. Markets are still disrupted, and risk-appetite remains weak across the board, though there have been occasional spikes of optimism.’
Investors were also looking for central bankers to lift interest rates by nearly 200 basis points over the coming six months as policy makers looked to cool rising inflation and tried to work in parallel with the US Federal Reserve.
‘Markets are looking for interest rate rises in Canada to be at the high end, though not high enough to nudge CAD’s value upward. Hiking interest rates could also aggravate Canada’s high levels of household debt and even cause a significant correction in the residential housing market.’
The bank’s prognosis pointed to a stark reversal for CAD. As the second half of 2022 kicked off, the Loonie remained the second-best performing currency of 2022 amongst G10 majors, trailing just behind the outperforming UD Dollar.
Gains last year were being driven by a blend of strong post-COVID economic growth, rising oil prices, and a strong demand from Canada’s biggest trading partner south of the 49th Parallel.
Despite all that, Desjardins analysts were looking for CAD to depreciate in the coming quarters. 'Our forecast is based on declining commodity prices, a cooling Canadian economy, and a likely correction in prices for residential real estate of around 15 per cent.’
Those factors combined suggested that the Bank of Canada might have to reduce its monetary tightening at a faster pace going into the Autumn.
Desjardins saw the Sterling to Canadian Dollar exchange rate reaching 1.5712 by the end of the thrid quarter of 2022 and 1.5865 by the end of December 2022. They also predicted CAD could come back to 1.6079 by the end of Q3 2023.
For the Greenback to Canadian Dollar exchange rate Desjardins was targeting 1.2985 by the end of Q3 2022, and 1.3331 by years' end. By the end of Q1 2023, the banks was targeting 1.3513.
The Euro to Canadian Dollar exchange rate was forecast at 1.3505 by the end of Q3 and 1.3731 by year’s end. By the end of the first quarter of 2023, it was expected to hit 1.3784.
While 2H 2022 has been good for Loonie bulls, it hasn't all been plain sailing. At the end of May CAD was headed toward the bottom of the G10 league table, having been outperformed by all but mighty USD. In fact, it started June just ahead of the Mexican Peso, which topped the G20 list.
Drifting CAD performance helped the Pound to Canadian Dollar exchange rate stay north of the 1.60 level for the most of this week’s session and might free the pair to recover ground lost recently if it can sustain that handle through the coming weeks.
In a research briefing at the time, RBC Capital Markets’ FX Strategy Unit said that the top cash rate had fallen by close to 20bps over consecutive sessions, and blamed ‘spillover’ from US market sentiment for the trend.
The impact was ‘symmetrical,’ RBC noted, as US trends can send Canadian cash rates higher or lower.
RBC also said that market expectations for the Bank of Canada’s (BoC) top cash rate dropped in late May in sympathy with their American equivalents.
That was significant since Canadian economic data had been minimal in recent weeks. It wouldn’t have been the first time CAD found itself tossed about on changing expectations for Federal Reserve (Fed) policy or changes in US economic conditions.