The Bank of Canada kept its key rate at 4.5% on Wednesday and is taking a break to observe the impact of its eight previous hikes on the Canadian economy. Meanwhile, in the United States, the Federal Reserve is suggesting that more increases are in store to deal with persistent inflation. Can the two countries take different paths, and what would be the impact?
Could the weakening of the Canadian dollar fuel inflation?
Yes. The Canadian dollar is currently depreciated against the American currency and its weakness should increase if interest rates remain at their current level in Canada and continue to rise in the United States. This depreciation will fuel inflation in Canada, since imports will cost more. The price of oil will rise with the Canada-US exchange rate, which will affect the pump and the cost of transporting many products. The price of fresh vegetables, heavily imported from Mexico and California, is also expected to rise, as will the cost of Ogunquit beach vacations.
“It’s counter-productive in the fight against inflation, but the inflationary effect of the lower dollar can be offset by increased exports,” explains Jocelyn Paquet, economist at the National Bank.
A weak dollar increases interest in Canadian products abroad and would help support the economy when it needs it.
For Canada, which is an exporting country, the net impact could be positive, he said.
It will be up to the Bank of Canada to find a balance between these moving parts of the economic chessboard. “There will be trade-offs to be made,” says Steve Ambler, member of the David Dodge Chair in Monetary Policy, professor at the University of Quebec in Montreal. Of course, the Bank of Canada will monitor the price of imports. There is no possible solution, only trade-offs. »
Should Canada raise interest rates at the same time as the United States?
No, says Steve Ambler. “Canada is an independent country, with a flexible exchange rate, which allows it to have a monetary policy independent of that of the United States. »
This does not mean that the monetary policy of the United States does not have an impact in Canada, “but it does mean that we do not have to stupidly follow what the Fed is doing, because inflation is going down faster here than in the United States”.
The Fed’s key rate is currently in the 4.5% to 4.75% range and is expected to rise further on March 21.
The Bank of Canada does not need to imitate the Federal Reserve because it does not need to go so far in rate hikes to slow the economy, believes Jocelyn Paquet. “The sectors most sensitive to rising interest rates, such as real estate, are larger in Canada than in the United States and react more quickly to rate increases. »
Following the Fed would therefore mean inflicting more damage than necessary to bring inflation back to the 2% target, he said.
What happens if the monetary policies of the two countries diverge?
It would be far from being a precedent, explains Jocelyn Paquet. Since 1995, he and his colleagues have noted several periods when interest rates were lower in Canada than in the United States, by 75 or even 100 basis points, which did not leave too many bad memories on this side of the border.
Higher rates in the United States would have the effect of weakening the Canadian dollar, since investors would be attracted by these higher rates.
This eventuality does not seem to worry the Bank of Canada too much, if we trust what Deputy Governor Paul Beaudry said on the subject in his speech on February 10. If the Canadian dollar drops, Canadian exports will be more attractive to foreign buyers, corporate profits will increase and so will employment, he summed up. “We shouldn’t be too concerned if the road Canada is taking to return to normality turns out to be slightly different from that followed by its trading partners. The important thing is that we arrive at our destination,” said the Deputy Governor.
The central bank is ready for a certain rate spread, but there is probably “a limit somewhere”, according to the National Bank. “With a key rate differential of 150 basis points or more, the Bank of Canada would certainly become more anxious,” analyze economists Taylor Schleich and Warren Lovely.
What does the Bank of Canada monitor?
Bank of Canada Governor Tiff Macklem often says a lot of things keep him up at night. The rate differential between Canada and the United States is one of them.
The astonishing vigor of the job market, which continues to support demand and the prices of goods and services, also continues to surprise the central bank. We will know on Friday whether the labor market remained solid in February, after the creation of 150,000 jobs in January. The central bank is concerned in particular about the average increase in hourly wages, which remains between 4% and 5%, which is incompatible with the return of inflation to the 2% target.
Another subject of concern is the intention of companies to continue to increase their prices, underlines the chief economist of the Laurentian Bank, Sébastien Lavoie. A Statistics Canada survey published last week indicates that a third of companies want to increase their prices in the coming months, a proportion that is not decreasing.
In its statement announcing its intention to maintain its key rate at 4.5%, the central bank says it expects the slowing economy to make it more difficult for companies to pass on their cost increases. on consumer prices.