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Expect the Bank of Canada Not to Wait for the Fed to Start Cutting Rates

30 April 2024

With the likelihood of a summer rate cut by the US Federal Reserve fading, there are growing concerns the Bank of Canada will be unable to diverge significantly from the Fed in its timing of any rate cuts. Despite this, the actual timing and extent of interest rate cuts by the Bank of Canada will be determined by domestic economic conditions, rather than by the gap between the policy rates of the Fed and Bank of Canada, or the value of the Canadian dollar.

We believe the Bank of Canada will cut rates earlier and more frequently than the Fed this year. A wider gap between Canadian and US interest rates will result in a weaker Canadian dollar, leading to higher prices for imported consumer goods. Historically, exchange rate movements between the US and Canada have not correlated strongly with broader inflation trends. Over half of Canadian consumer spending is on services, and goods are imported from various countries, not just the U.S.

Canada is a small open economy. Our floating exchange rate enables interest rate policies to diverge across regions and acts as a shock absorber for the economy through trade and balance of payment adjustments. The final price of goods depends on exchange rates as well as transportation cost and retailer mark-ups. Transportation costs have been declining, with the cost of freight trucking, for example, down 6% from levels a year ago, while a weaker economy makes it more difficult to pass increased import prices on to consumers.

The US dollar has shown strength against most currencies, but when assessed on a trade-weighted basis, the Canadian dollar has performed better. More than 65% of final consumer goods come from countries other than the US, with nearly 20% of Canada’s consumer goods imports and over 30% of electronics coming from China. In comparison, our loonie has fared better against the renminbi, the official currency of the People’s Republic of China.

More than half of total household spending goes towards services. Price growth for these services will be determined by domestic demand and inflation expectations. With the economy softening over the past year and a half, businesses are finding it challenging to pass on price hikes while remaining competitive. We are seeing signs of weaker wage growth and declining demand for hiring.

If prices in the goods market are slow to respond to changes in monetary policy, we could see some overshooting in the foreign exchange market to compensate for sticky goods prices in the economy. However, this adjustment will not be a factor in any decision by the Bank of Canada to move independently from other central banks.

Housing Affordability Watch

CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis

The 2024 federal budget offers a range of strategies to address the housing crisis in Canada. It includes broad-based initiatives aimed at increasing housing supply, supporting the rental market, assisting young Canadians in accessing affordable housing, and combating homelessness. However, questions linger about the feasibility and effectiveness of these initiatives. Considering that changes in affordability will take years to materialize, skeptics may argue that the groundwork is being laid to justify potential future shortcomings in achieving the budget’s housing goals. Get the full take in our latest Housing Affordability Watch. Read it here: Budget 2024 – A New Housing Road Map


Independent Opinion

The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.

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