head of bank of canada says there is a “limit” to how much Canada’s monetary policy can differ from the United States as market watchers see the first cut north of the border.
Governor Tiff Macklem was asked about the impact of US monetary policy on the Bank of Canada Rate of interest Path during an appearance at the House of Commons Standing Committee on Finance on Thursday morning.
He said the Bank of Canada’s benchmark interest rate, which remains at five per cent after six consecutive decisions, does not need to reflect the monetary policy of other central banks around the world.
But he also said that “there’s a limit to how far they can vary.”
“We are nowhere near that limit. We have the ability to steer our monetary policy in line with the needs of Canadians,” he said.
The Bank of Canada’s policy rate is already lower than the US Federal Reserve maintained its interest rate range on Wednesday Of 5.25-5.5 percent.
Macklem’s counterpart south of the border, Jerome Powell, then said that inflation was proving more stubborn than previously thought, and that it would “take longer than previously expected” for the Fed to gain the confidence needed to cut interest rates.
Why do US Fed rates matter to Canada?
James Orlando, director of economics at TD Bank, says the difference between Canadian and US interest rates could weaken the exchange rate between the loonie and the US dollar as investors gravitate towards the US dollar to benefit from higher rates.
The currency stood at 73 cents against the US dollar as of Thursday afternoon, although Orlando says it has hovered between 72 and 76 cents for most of the last year.
With market expectations that the Bank of Canada will cut interest rates in June or July followed by a rate cut by the Fed in November or December, Orlando says the widening gap between rates will weigh on the Canadian dollar in the coming months. Even more pressure is expected. come.
Macklem told lawmakers on Thursday that market expectations are already baked into the CAD-USD exchange rate, with some of the effects of those earlier moves already priced in.
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The Bank of Canada does not target any specific exchange rate for the loonie in its mandate; The central bank’s focus is on achieving price stability and two percent annual inflation.
Inflation in Canada has declined significantly from its highest level in more than 40 years two years ago, Coming at 2.9 percent in March, This compares with 3.5 percent in the US
Stalled progress south of the border in taming inflation has dampened expectations for a pace of Fed rate cuts compared with the start of the year.
How does the Canadian-US dollar exchange rate affect inflation?
But a weak paranoid could damage the Bank of Canada’s progress in fighting inflation. The low exchange rate for the Canadian dollar makes imports from the US and some other global markets more expensive, which could raise consumer prices and increase inflation.
The National Bank of Canada published a report Thursday detailing how much prices could rise if the two central banks’ policy rates differed significantly.
Authors Warren Lovely and Taylor Schleich wrote that they are not convinced by the argument that a Bank of Canada rate cut would be “counterproductive” to fighting inflation.
A wider rate differential than today between the Bank of Canada and the US Fed is “not unusual”, the authors wrote.
The report said the impact of higher import prices on consumers is “less than widely appreciated”.
A 10 per cent decline in the loonie’s value against the US dollar would lead to only a 25-30 basis point increase in core inflation, economists said, citing Bank of Canada research models.
Although there is probably a level of depreciation in the loonie that would cause concern among the Bank of Canada, Lovely and Schleich argue that “it is entirely appropriate for the Fed to set the (central bank’s) policy rate without ignoring policy makers. It may fall by 100 bps.
Orlando agrees that fears about the exchange rate won’t be enough to stop the Bank of Canada from making earlier rate cuts, the first of which he plans to do at the central bank’s July meeting.
But after that point, he suspects Canadian monetary policymakers will be reluctant to move too quickly with the US Fed lagging behind.
“The Bank of Canada may be hesitant about how quickly it wants to cut interest rates because it doesn’t want to get too ahead of the Fed,” he says.
American consumers are in a better position to withstand rate hikes
Orlando points out that the interest rate tightening cycle has had a greater impact north of the border than in the US, largely due to the “heavily indebted” Canadian consumer.
Orlando says that after the 2008-09 financial crisis, American consumers reduced debt at a significant pace – getting rid of their debt. This has made them less sensitive to higher borrowing rates than their Canadian counterparts.
Orlando says Americans also tend to take longer terms on their mortgages, more than 30 years, while Canadians are typically renewing their rates every five years or less, allowing more rapid changes in monetary policy. Is.
He points out that those differences have allowed the U.S. economy to remain strong despite high interest rates, while Canadian spending has shrunk.
But Orlando believes the Bank of Canada is being cautious about the timing of its rate cuts because it is wary of a resurgence in the Canadian economy mirroring the U.S. case. While they don’t expect those conditions to materialize, any signs such as employment or wage growth could lead to a spending boost that boosts inflation and push back a rate cut deadline for the Bank of Canada. Is.
Orlando says that alternatively, rising geopolitical risks — including the U.S. elections in November — or other factors weakening the already struggling Canadian economy could cause the central bank to raise rates earlier and more often. Can force you to cut back.
“The direction is towards cuts around July, after that the pace of cuts would be quite reasonable,” he says. “But these are all things you have to look at to see if the story is changing, “To see if that’s something the Bank of Canada should pursue one way or another.”
