Weaker Canadian Dollar May Not Stop BoC’s Divergence From Fed’s Path

In order to prevent a falling currency that could jeopardize the outlook for inflation, the Bank of Canada is prepared to lower interest rates three times before the Federal Reserve takes its initial action.

Investors are debating whether or not the Bank of Canada would deviate from its American counterpart due to the Canadian dollar’s poorer value relative to the US dollar this year. Investors anticipate that the Canadian central bank will start reducing interest rates in June or July, with this Tuesday’s inflation report being a crucial factor.

Even in light of Wednesday’s lower-than-anticipated U.S. inflation numbers, the Fed is still expected to remain on hold until September. At 5%, the benchmark interest rate of the Bank of Canada is now 38 basis points less than the middle of the Fed’s policy rate range. The pressure on the Canadian currency can increase if the gap continues to deepen.

According to analysts, a significant shift in the currency would be necessary to raise import prices to the point where the central bank’s goal of 2% inflation would be jeopardized.

The Bank of Canada’s ability to lower its policy rate below the Federal Reserve funds rate has a theoretical ceiling, but it’s probably much below the current levels. If interest rates were to increase further, the exchange rate might depreciate, but the inflationary impact should only be slightly felt.

Recent quarters have seen Canada’s economy lagging behind the US economy due to slower productivity growth, higher household debt levels, and a shorter mortgage cycle.