Yahoo Finance Bank of Canada can stomach faster rate cuts than the Fed, say economists
The Bank of Canada could cut its benchmark interest rate up to three times before the Federal Reserve begins moving rates lower, say economists, downplaying the risk of a widening policy rate gap between the central banks.
For nearly two years, economic growth in the United States has left Canada in the dust. CIBC Capital Markets and TD Economics say that should give Bank of Canada governor Tiff Macklem confidence to ease borrowing costs faster than the Fed.
The Bank of Canada is widely, thought not universally, expected to trim its overnight rate by 25 basis points to 4.75 per cent on June 5. Cooling inflation figures for April and slowing first-quarter GDP growth have helped make the case for a cut. It’s a different story stateside, where a strong services sector and government spending have created pockets of inflation, leaving Fed officials less certain on when to cut rates.
TD’s James Orlando expects Canada’s real GDP growth to remain less than half of that in the U.S. throughout 2024, reinforcing the Bank of Canada’s conviction in rate cuts.
“Below-trend growth in Canada should make the Bank of Canada confident that it has inflation under control,” he wrote. “The Fed, however, does not have this luxury.”
CIBC’s Ali Jaffery says his bank’s base case forecast is two 25 basis point cuts by the Bank of Canada before the Fed starts to lower interest rates in the U.S. in September.
“The 100 basis points of cuts we predict in Canada will be double that seen in the U.S., and widen the current spread up towards one per cent,” he wrote in research published on Monday. “They could cut two-to-three times before the Fed, and could manage a 100 basis point gap for some time.”
TD Economics sees the Bank of Canada beginning to lower rates this summer, accelerating cuts into the end of 2024. TD expects the Fed to begin cutting in December.
“That means the spread between the Bank of Canada and Fed policy rates would hit 125 bps, before the Fed starts to accelerate its own rate-cutting pace,” Orlando wrote in a research note last week. “This implies that the Bank of Canada will be managing monetary policy according to what is happening in Canada, with an eye fixed on what’s happening in the U.S.”
While the neighbouring economies have historically moved in the same direction, Canada has persistently underperformed in recent years.
Jaffery says the main argument for limiting divergence between the Bank of Canada and the Fed is the inflationary impact of weakening the loonie. That would be a bigger deal, he says, if both economies were firing on all cylinders.
“Importing firms in Canada don’t have a lot of room to pass on higher prices to consumers, and will likely be forced to absorb some of the higher cost of imports through lower margins. The inflationary impact should therefore be somewhat smaller compared to an environment where both economies were strong,” he wrote. “As the Bank tries to find the limit of how far it can diverge from the Fed, for now, it should be free to run its own race.”
Orlando also hopes Macklem won't be overly swayed by factors south of the border when deciding the trajectory of rates in Canada.
"If there is one thing we have learned since central banks started hiking rates, it’s that interest rates affect economies differently," he wrote. "The Canadian central bank needs to react to what is happening at home."
Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.
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