According to a straw poll of seven analysts, the Bank of Canada is open to cutting interest rates three times before the Federal Reserve makes its first move, in order to prevent a declining currency from jeopardizing the inflation outlook. This year, the Canadian dollar has weakened against the U.S. dollar, prompting debate among investors about how much the BoC would diverge from its U.S. counterpart.
Investors anticipate that the Canadian central bank will initiate rate cuts in June or July, with next Tuesday’s inflation report expected to influence the decision. In contrast, the Fed is expected to maintain its rates until September, despite lower-than-anticipated U.S. inflation data released on Wednesday.
The BoC’s benchmark interest rate, currently at 5%, is already 38 basis points below the midpoint of the range set by the Fed for its policy rate. A further widening of this differential could increase pressure on the Canadian dollar.
However, analysts believe that a substantial depreciation of the currency would be necessary to significantly raise import costs and endanger the central bank’s efforts to reduce inflation to its 2% target. Higher import costs typically lead to increased consumer prices as businesses adjust their pricing accordingly.
The latest data indicates that inflation stood at an annual rate of 2.9% in March, down from its peak of 8.1% in June 2022. Analysts polled by Reuters expect year-on-year consumer price inflation to be at 2.8% for April. Statistics Canada will release the official data on May 21.
Since the beginning of the year, the Canadian dollar has weakened by nearly 2.7% against the U.S. dollar, reaching 1.3602 per U.S. dollar, or 73.52 U.S. cents, as the greenback strengthened against a basket of major currencies.
Olivia Cross, North America economist at Capital Economics, noted that as a rule of thumb, a 10% depreciation in the Canadian dollar would increase core goods prices by 2.5%. Core goods constitute about 30% of the Canadian CPI basket.
Bank of Canada Governor Tiff Macklem stated earlier this month that there is a limit to how much U.S. and Canadian interest rates can diverge, but currently, they are not near that limit.
The Canadian economy has trailed behind the U.S. economy in recent quarters, hindered by lower productivity growth, higher household debt levels, and a shorter mortgage cycle. Some economists argue that these factors should prompt the Bank of Canada to act before the Federal Reserve.
According to the OECD, Canada’s economy is projected to grow by 1% this year, a much slower rate compared to the 2.6% growth forecasted for the United States.