GBPCAD Analysis – Rising inflation

Date published - 6 Jun 2022

Macroeconomic backdrop

The Great British pound tumbled 0.7% against the Canadian dollar on Wednesday (18th May), falling to a five-year low, after April economic data (CPI) showed slowing growth in the UK economy, thus sparking fears of stagflation.

Official figures released by the Office for National Statistics showed UK inflation rose to 9% - its highest level in 4 decades. The latest inflation figures are in line with the BoE's forecast which pegged this year's inflation at 10%. The UK central bank has warned that this could tip the economy into recession.

The overheating inflation has had a ripple effect on the currency markets with traders anticipating that the Bank of England could be forced to take a more dovish stance.

On the flip side, Canadian CPI data for April came in above expectations, showing that inflation continues to be stickier and more persistent than originally expected.

Core inflation rose by 5.7% on an annualized basis, surpassing economists' forecast of 5.4% and March’s inflation figure of 5.5%. The broader CPI index rose 6.8% YoY, representing a new multi-decade high.

The Canadian CPI would no doubt embolden the Bank of Canada to embrace a more hawkish approach and tighter monetary policy, as inflation remains well above the BoC’s 2% target.

With the financial markets anticipating that the Canadian central bank will raise its benchmark interest rate by another 50 basis points (0.5%) on June 1st, traders may look to price in more hikes down the road.

A dovish BoE and a more hawkish BoC tilt the market sentiment in favor of the CAD as investors continue to avert risk. This is further exacerbated by rising oil prices, which are being buoyed by the war in Ukraine and OPEC, which keeps a tight lid on its production levels. It would further put more bearish pressure on the currency pair.

The GBP/CAD pair has accelerated its drop in the past week, with the Pound falling 0.5% against the Canadian dollar (as of the time of writing). This is despite the fact that GBP produced its largest single-day rally in 17 months on May 17th.

Technical Analysis

Feat Img

Technical levels on the weekly chart at the time of writing (18th May 2022) show that the pair may be poised for a reversal against the CAD after dropping for 11 weeks out of the last 12 (from 21st February 2022).

Candlestick patterns on the weekly chart at the time of writing show that a gravestone Doji is beginning to form this week, retesting the key support level at 1.58831. Chartists deem the formation of a gravestone Doji chartered by a long upper tail and small lower body as a bearish sign.

The RSI indicator shows that the currency pair is deep in oversold territory at the 25.23 mark. The Parabolic SAR also shows strong selling pressure on the pair. The indicator has been in a steep decline since February 21st when the pair hit the 1.5871 mark.

The MACD histogram shows selling pressure which appears to be weakening in the last week. This is due to the GBP astronomic rally earlier in the week ( May 17th). Bollinger bands also show lower levels after maintaining the zone between the 1.6645 and 1.77560 price levels since December 2019.

In all, technical indicators show that the bears are very much in control, but it appears that the grip may be loosening as the bulls gain strength, albeit little.

However given the resistance put up by bears especially in the 1.6000 psychological level as evidenced by the gravestone Doji, the uptrend looks more like a dead cat bounce as support may be broken.

Analyst Insight

The GBP/CAD pair may be in the early stages of a reversal after hitting its lowest point since August 2019. However, there is still much frothiness on the strength of this reversal.

Technical indicators show strong selling pressure on the currency pair, with bears firmly in control from the 1.6000 psychological level. Already, the pair is flirting with the 1.5833 support level, having broken through previous support at 1.6745 in February for the first time since January 2020.

Given the sentiment in the market, there is a strong possibility this level may be broken. Already the gains from GBP’s astronomic spike on Tuesday (May 17th) have been erased by Wednesday's plunge.

Rising commodity prices exacerbated by the war in Ukraine and supply chain constraints still imply that there is much tailwind for commodity currencies like the Canadian Dollar against risk assets such as the Pound Sterling.

Strength in the CAD should be further buoyed by the BoC pulling the plug on its bond-buying program as it begins to raise interest rates to cool what it calls an "overheating" economy.

The Bank of Canada raised its key interest rate target by half a percentage point to one percent last month in a bid to help slow inflation and warned that more rate hikes are coming.

The hot Canadian CPI data for April also strongly suggests that the BoC would introduce more rate hikes, strengthening the CAD.

GBP on the other hand faces a different fate. With inflation in the UK currently higher than in Canada and the U.S., analysts believe that the BoE would retrace from its hawkish stance.

This would certainly douse any upward movement in the pair despite the Bank of England's hawkish stance.

The drop on May 18th reversed most of the gains the Sterling made the day before. The sharp pullback puts the currency pair firmly below the psychological 1.6000 level at the time of this writing.

Chart patterns and technical indicators show that sellers are defending this level vigorously suggesting that it would take an unexpected monetary policy change from the BoE for the Pound stage a rebound.

On the flip side, if downside pressure accelerates and sellers breach the 1.5800 level decisively, the GBP/CAD could be on its way to retesting lows not seen since 2012.

If markets begin to price in a more forceful monetary policy response to the current inflationary environment from the BoE, GBP/CAD should stabilize and manage to retrace some of the 2022 losses.

Current CPI figures show that the UK has shot past Canada's (and the United States) inflation numbers. This adds to the bearish sentiment on the GBP/CAD pair, with the CAD buoyed by the belief that the BoC is in a stronger position to hike rates faster and higher than its UK counterpart. Traders are also pricing in the effect of the bullish run on oil prices which is good for the Canadian economy.

Geopolitical risks from Brexit are also another source of bearish sentiment on the pair. The proposed changes to the Northern Ireland protocol which have the potential to spark a trade war with the European Union are another major downside risk for the Sterling.

In conclusion, the GBP/CAD pair is expected to continue its downward trajectory in the short term until traders get clarity on the BoE's next move.

Blog User

Chika Nwakanma

Chika specialise in stock market, personal finance, investing and money management. His articles have appeared on Yahoo Finance and Insider Monkey. Chika is a result oriented and able to analyse market movements and translate his findings into well written articles with ease.

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