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the BoC is planning to maintain rates at their pre-financial crisis high of 4.50%; however, this does not necessarily suggest that they will be dropped as quickly as they were nearly 16 years ago.

It is time for the Bank of Canada (BoC) to follow through on its promises to stop raising interest rates before its competitors. The “pivot” statement has weakened the Canadian Dollar since investors now anticipate the BoC’s next action to be a reduction in borrowing costs. 

The institution in Ottawa last made a decision and raised the overnight rate to 4.50% in late January. At the time, it made it plain that a halt was set to occur, and data on inflation supported this decision. In the most recent reading for January 2023, Canada’s Core Consumer Price Index (Core CPI) slowed from a peak of 6.2% to 5% YoY.

The overnight rate is probably going to stay at 4.50% despite the Bank of Canada raising interest rates eight times since the first quarter of 2022. This trend is anticipated to cease at the policy meeting on Wednesday. If true, this would be a watershed moment and widen the gap between the Fed’s and BoC’s policy divergence. As a result, a positive breakout might occur in the USD/CAD. That is assuming Jerome Powell does not ruin the dollar bulls’ party on Tuesday afternoon by any surprisingly dovish comments. The Fed Chair is due to testify about Semi-Annual Monetary Policy Report before the Senate Banking Committee, in Washington DC.

Core CPI represents expenses that typically remain around for longer, such as services that depend on salaries, and excludes volatile food and energy prices. The Bank of Canada keeps a close eye on the US Federal Reserve’s (Fed) emphasis on inflation linked to the labour market.

Yet, the Fed has stated that it plans to keep raising rates, in part due to the tight labour market in the United States. With five months in a row of better-than-expected growth, Canada is no exception.

Canada, which welcomes more immigration and yet has a low unemployment rate of 5.1%, continues to have a strong need for labour. Canada may soon experience greater salaries in addition to lower interest rates due to the labour market’s rapid development.

According to analysts at ING, “Canada is much more exposed to interest rates rate hikes via a higher prevalence of variable rate borrowing and high debt levels versus the US.” ING points to the fact that in the US, the 30-year fixed rate mortgage is the most common borrowing method. But in Canada, they have highlighted that it is five years or less. This makes Canada’s housing market more sensitive to interest rate changes. What’s more, Canadian household liabilities are equivalent to more than 180% of disposable income versus 103% in the US, notes ING, and that house prices “in several cities are ten times greater than average household incomes, whereas in the US it is typically five to six times income.”

Given that monetary policy operates with lengthy and variable delays and that labour market data tends to be the most trailing of all lagging indicators, the poor growth and disinflation story should take precedence over the jobs statistics. The Bank of Canada has increased interest rates by 425 basis points in only eight sessions, including a 100 basis point change in July. Yet, Canada is significantly more vulnerable to interest rate increases than the US due to a larger incidence of variable rate borrowing and high debt levels. For instance, the most popular borrowing option in the US is a 30-year fixed-rate mortgage, but in Canada, it often takes five years or less before interest rates change.

We are worried because, compared to most other major economies, the Canadian economy is expected to be more affected by the interest rate increases now in effect. In fact, we anticipate that the economy will actually decrease later this year, which will assist to lessen pricing pressures. As a result, we see a strong chance that the BoC will end up reversing course and cutting interest rates later in the year.

The BoC could rely on the robust labour market to provide room for future interest rate increases, which would strengthen the Canadian Dollar. The first step before lowering rates may be to cease rises, but this might also be only a pit stop on the way up.

One day after the Reserve Bank of Australia (RBA) expressed a less hawkish tone, hinting at an early stop to rate rises, Bank of Canada officials announce their rate decision. Markets frequently extrapolate from one central bank to another since both nations export goods.

Investors are likely watching for an indication from Canada of a protracted delay that may finally result in a cut, also based on the RBA’s decision. The United States and its robust economy are more reliant on Canada than Australia, whose economy is shrinking as China’s growth prospects deteriorate.

Overall, the BoC is planning to maintain rates at their pre-financial crisis high of 4.50%; however, this does not necessarily suggest that they will be dropped as quickly as they were nearly 16 years ago.