Input text Rate Hikes: Bank of Canada’s Pause Threatened by US Fed’s Ongoing Inflation Fight, Say Economists
Economists assert that the likelihood of the U.S. Federal Reserve continuing to raise its federal funds rate puts the Bank of Canada’s pause on raising interest rates in jeopardy.
Benjamin Tal, deputy chief economist at CIBC, stated to The Epoch Times that the BoC cannot “divorce itself” from the Fed for an excessive amount of time. This is about how much higher the U.S. central bank can raise its policy rate than the overnight rate target set by the Canadian central bank.
He stated, referring to the extent to which the Fed’s key rate can exceed the BoC’s, “The Bank of Canada will tolerate 50, 75, even 100 [basis points], but not more than that.” 0.01 percent is the value of a basis point.
With the BoC’s overnight rate target at 4.5 percent and the Fed’s target range between 4.5 percent and 4.75 percent, the difference between the two policy rates is currently negligible.
However, markets anticipate that the Federal Reserve will raise rates to anywhere from 5.5% to 5.75% and possibly even higher by the summer, despite the fact that the Bank of Canada is delaying rate increases to observe how the Canadian economy responds.
Tal stated, “The Bank of Canada will react if the Fed goes and separates itself from the Bank of Canada by more than 100 basis points” due to the impact on monetary conditions, particularly the weakening Canadian dollar.
On February 1, the Fed increased its key policy rate by 25 basis points. Before falling 1.9% in February, the Canadian dollar had gained 1.5% in January.
After a positive January, stocks and bonds have also suffered in February.
The Fed’s preferred inflation measure, the personal consumption expenditures (PCE) price index, rekindled financial markets’ concerns about a more hawkish Fed. Rising U.S. Inflation From December to January, its core reading, which does not include food or energy, increased by 0.6% month-over-month and by 4.7% year-over-year.
According to Doug Porter, chief economist at BMO, the 10-year treasury note yield in the United States surpassed 3.95 percent for the first time in 2023, and the 2-year yield surpassed 4.8% for the first time since the global financial crisis of 1995. Furthermore, the Canadian dollar fell below US$0.735.
According to Porter, “The Bank [BoC] may not have the luxury of staying on the sidelines if the Fed is still busy marching rates down the field, driving the loonie lower (and thereby sending imported costs flaring higher),” adding that import prices were up 13% year-over-year in the fourth quarter. Porter also mentioned that import prices were up 13% year-over-year in the fourth quarter.
TD stated on February 24 that “the details of the report should be concerning for Fed officials” in response to the release of the PCE data, and the Bay Street Bank highlighted a notable risk that the Fed’s funds rate could reach 5.75 percent by July.
The Fed’s minutes from its meeting on February 1 showed that policymakers are more worried about rising inflation than about the possibility of a recession.
What should the BoC expect?
The BoC anticipated that U.S. inflation would continue to ease in its quarterly forecasts, which were made public on January 25. The bank did not mention the possibility of a stronger U.S. economy and a more aggressive Fed in its “Risks to the inflation outlook,” which could weaken the Canadian dollar and increase inflation through import prices.
According to Tal, the BoC can sometimes be fulfilled by the Fed by raising rates and cooling Canada’s economy. However, that is not the case right now.
The fact that the U.S. economy is not slowing down sufficiently actually hurts the Bank of Canada.
He adds that the impact on the Canadian economy would be twice as great if the BoC had to raise rates to keep up with the U.S. economy if the Fed did the same.
According to Tal, this is because Canadian households are more sensitive to interest rates and have higher debt loads. For instance, mortgages in Canada typically renew every five years, whereas in the United States, homeowners typically lock in their borrowing costs for a period of thirty years.
Economists wonder how much central banks need to raise interest rates to bring inflation back to the target of 2%. Given the longer-term macro drivers that serve to fuel inflation, such as higher wages due to worker shortages and the transition to renewable energy, whether the 2% target continues to make sense is a related question.
De-globalization, the labor market, and “green initiatives,” according to Tal, are all ingrained forces that are inflationary.
The question now is whether or not the Fed and Bank of Canada will tolerate future inflation. They probably won’t do it soon, in my opinion. However, that is something to consider.”
In a speech delivered on February 16 in Edmonton, deputy governor Paul Beaudry reaffirmed the bank’s commitment to the 2% goal.
The bottom line is that if Canada follows a slightly different path to normalization than our counterparts, we shouldn’t be too concerned. “Getting there is the most important thing,” he said.
