“The magnitude of the policy rate deviation between the Fed and the BoC relative to differences in their macroeconomic circumstances makes me concerned about the extent to which it is assumed the BoC can fall behind the Fed,” says Scotiabank economist Derek Holt.
Earlier in the week, U.S. Federal Reserve Chairman Jerome Powell testified before the U.S. Senate.
Powell gave every indication that interest rate hikes in the United States would continue.
“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” said Powell. “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”
By contrast, interest hikes have been paused in Canada, with the Bank of Canada holding the benchmark rate at 4.5%.
As a result, there is likely to be a growing gap between interest rates in Canada and the United States.
And as noted by Derek Holt – VP and head of capital markets economics at Scotiabank – this won’t be without consequence:
“If Q1 GDP rebounds and given ongoing strength in the job market and awful productivity then the case for sustained evolution of core inflationary pressures toward the 2% headline target may be stated prematurely here.”
Holt is also concerned the Bank of Canada isn’t bothered by potential Canadian Dollar weakness:
“A further case for this argument is that apparently, CAD isn’t enough of a concern to the BoC just yet. We’ll see what SDG Rogers says about it tomorrow if anything. The only reference was to strike out how the C$ “has been relatively stable against the US dollar” and replace it with “…the US dollar has strengthened.”
If the Fed is on the march to 6% and the BoC is turning dovish at the margin then CAD has 1.40 in its sights. That will challenge the BoC’s assertion that it will be more difficult to pass on cost pressures. I think they did a misstep here and are sitting ducks to currency traders.”
Holt expressed concern that the gap is becoming too large:
““The magnitude of the policy rate deviation between the Fed and the BoC relative to differences in their macroeconomic circumstances makes me concerned about the extent to which it is assumed the BoC can fall behind the Fed,” Holt said.”
As explained by Investopedia, a weaker currency can drive up inflation – at least in the short-term:
“Because more of a weak currency is needed when buying the same amount of goods priced in a stronger currency, inflation will climb as nations import goods from countries with stronger currencies. Eventually, the currency discount may spur more exports and improve the domestic economy, provided there are no systematic issues weakening the currency.”
Trapped?
One gets the sense that the Bank of Canada now feels trapped.
Canada’s weak productivity means growing our way out of our consumer debt burden appears unlikely.
At the same time, that debt burden makes Canadians more vulnerable to interest rate hikes.
Yet, responding to that vulnerability by keeping rates lower could drive up inflation, which will itself lead to many Canadians having to take on more debt to keep their heads above water.
We are seeing the result of economic policies that value government spending over private sector growth.
Sooner or later, Canada will have no choice but to embrace more private sector competition, because there is no way out of this trap without a significant increase in our economic productivity.
Spencer Fernando
