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Widening UK Trade Deficit Limits GBP CAD Exchange Rate Gains

August 10, 2017 - Written by David Woodsmith

An unexpected widening of the UK trade deficit weighed on the Pound Canadian Dollar exchange rate, even though a general sense of risk aversion prevented any particular weakness.

Markets were not impressed to see this fresh deterioration in the UK’s trade balance, however, as uncertainty over Brexit continues to hang over the domestic economy.

The latest industrial and manufacturing construction figures also failed to offer any particular encouragement to investors on Thursday morning.

While industrial output showed a modest rebound after May’s lacklustre performance the sector continued to underperform over the longer term, suggesting that the economy is still in a less healthy state.

As James Smith, economist at ING, commented:

‘ It’s been a disappointing morning in terms of UK data. Headline industrial production data was flattered by a 5% MoM rise in oil and gas output, but manufacturing remained flat on the month. Manufacturing output hasn’t increased in any month so far this year.

‘This is particularly concerning when you consider the backdrop of a 13% post-Brexit fall in the pound and the significant improvement in global growth prospects (particularly in Europe, a key trading partner for the UK). Whilst these developments appear to have boosted sentiment amongst manufacturing firms according to recent PMIs, we aren’t seeing this being translated into the official data.’

Altogether this does not paint the most encouraging picture for the Pound, with the prospect of any return to hawkishness for the Bank of England (BoE) looking increasingly distant.

Resilient Oil Prices Limit CAD Downside

Escalating tensions between the US and North Korea have weighed heavily on the Canadian Dollar this week, with investors inclined to sell out of risk-sensitive currencies.

As the threat of an armed conflict between the two states appears to mount the appeal of the ‘Loonie’ remains limited, in spite of positive domestic data.

Even though both the Canadian housing starts and building permits figures bettered expectations on Wednesday this failed to give the commodity-correlated currency any particular support.

However, oil prices have proven surprisingly resilient even in the face of global geopolitical worries thanks to a surprisingly sharp decline in US crude inventories.

With Saudi Arabia also pledging to cut its supply volumes to many of its Asian buyers there are hopes that the global oversupply glut could ease in the coming weeks, limiting the downside potential of the Canadian Dollar.

If this afternoon’s new housing price index also points towards an improvement in the Canadian housing market this may put further pressure on the GBP CAD exchange rate.

Any disappointment, though, could give the Pound an opportunity to extend its recent gains as confidence in the strength of the Canadian economy remains somewhat muted.

As long as global risk aversion remains heightened this is likely to keep the Canadian Dollar biased to the downside.

Pound Forecast to Weaken Ahead of UK Inflation Data

Confidence in the Pound is likely to deteriorate in the near future, however, as investors brace for Tuesday’s UK consumer price index report.

In spite of the dovishness of the BoE’s recent policy meeting any uptick in inflationary pressure could encourage speculation that an interest rate hike may not be off the table.

On the other hand, if inflationary pressure fails to show any acceleration in July this may put an end to bets that the BoE could return to a tightening bias before the end of the year.

Either way, GBP exchange rates may struggle to hold onto any strength for long, given the less positive outlook of the domestic economy.

Analysts at Scotiabank warned that:

‘Sharply higher inflation and sluggish wage inflation have pushed household real disposable income growth into negative territory, crushing household consumption growth.

‘While there is a glimmer of hope that investment and net trade could provide an offset, we remain glass half-empty on growth during 2017. We expect growth of just 1.6% y/y.’

Any further developments regarding Brexit could provoke additional volatility for the GBP CAD exchange rate, with signs of a hardening approach from the UK government likely to discourage markets.
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