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The Bank of Canada’s divergence from the US Fed puts the crazy man in the spotlight
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Falling Canadian dollar could fuel inflation, but central bank says those concerns are a long way off
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Published June 8, 2024 • Last updated 13 hours ago • 3 minute read
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The loonie was trading just below 73 cents on Friday. Photo by Paul Chiasson/Canadian Press Archives
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O Bank of Canada trimmed your interest rate policy by 0.25 percent this week, but with the United States Federal Reserve While overnight rates are expected to remain stable until the autumn, questions are being raised about how far the gap between the two countries’ policy rates will grow.
Sadiq Adatia, chief investment officer at BMO Global Asset Management, said Canadian and U.S. rates have diverged by 50 basis points or more over the years, but could exceed that range given unique economic growth and inflation photos in each country.
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This divergence will likely cause the Canadian dollar to fall, he said, and there are some concerns it could fuel inflation.
Philip Petursson, chief investment strategist at IG Wealth Management, wrote in a note this week that there is a risk that the Canadian dollar falling to between 70 and 72 US cents if the Bank of Canada cuts rates by 50 basis points more than the Fed in 2024.
“This will erode our purchasing power and cause money to move to other parts of the world where the rate differential is much better,” said BMO’s Adatia. “If the divergence is really big and happens quickly, we could see a rise in inflation.”
However, he assigned a low probability to this outcome, noting that a large divergence is not his base case.
The loonie was trading just below 73 cents on Friday.
I don’t think we’re anywhere near that limit
Tiff Macklem
Tiff MacklemGovernor of the Bank of Canada, downplayed currency concerns during a press conference on Wednesday, noting that the two countries’ overnight rates have diverged in the past without lasting damage to their economies or markets.
Recognizing that there is a point at which such divergence could have negative impacts, he said: “I don’t think we are close to that limit.”
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Macklem added that there is no “bright line” to determine a tolerable size for the gap and added that there have been periods of “significant” divergence in the past.
Doug Porter, chief economist at the Bank of Montreal, said the “outer bound” of the difference between Canadian and U.S. overnight interest rates for most of the past 20 years has been 100 basis points, or one percentage point with the current Canadian or US rate. the upper segment, although he added that the divergence was even greater at times during the 1980s and 1990s.
“Unless there were some other factor at play – such as strong commodity prices or a broadly weak US dollar – an interest rate difference of more than 100 basis points would likely put serious downward pressure on the nutjob,” he said. Porter.
However, he suggested that the Bank of Canada’s willingness to ease monetary policy shows that central banks do not appear to be especially concerned about the potential for further currency easing. Additionally, Porter noted that previous predictions about the gap’s impact have not been borne out.
In 2003, for example, the biggest rise in the Canadian dollar in a single year – more than 20% – coincided with a 200 basis point differential between Canadian and US rates, but did not have the expected impact on inflation.
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“It fell, but not to the extent that the models expected inflation to fall in the face of a 21% increase in the loonie,” Porter said.
And why didn’t the economy react more strongly to the enormous change?
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“I believe companies are much more sophisticated now in hedging currency risks than they were in the 1970s and 1990s,” he said.
“Especially after the big swings of the 1990s, they really learned how to deal with exchange rate volatility.”
• Email: bshecter@nationalpost.com
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