Bank of Canada’s deviation from US Federal Reserve brings attention to the loonie

The Bank of Canada recently made a move to trim its policy interest rate by 0.25 per cent, sparking concerns about the widening gap between Canadian and U.S. key lending rates. Sadiq Adatia, chief investment officer at BMO Global Asset Management, highlighted the potential for the gap to exceed historical ranges due to unique economic growth and inflation dynamics in each country.

Philip Petursson, chief investment strategist at IG Wealth Management, warned of a possible decline in the Canadian dollar to between 70 and 72 cents US if the Bank of Canada cuts rates by 50 basis points more than the U.S. Federal Reserve in 2024. This could lead to a decrease in purchasing power and a shift of money to regions with more favorable rate differentials.

Despite concerns about stoking inflation, Tiff Macklem, governor of the Bank of Canada, downplayed worries about currency impacts during a recent news conference. He emphasized that past divergences in overnight rates between Canada and the U.S. did not have lasting negative effects on their economies or markets.

Doug Porter, chief economist at Bank of Montreal, discussed the historical limits of the Canada-U.S. overnight interest rate gap, noting that a spread of more than 100 basis points could put significant downward pressure on the Canadian dollar. However, he highlighted the central bank’s willingness to loosen monetary policy as a sign that concerns about currency softening may not be a top priority.

Porter also pointed out that past predictions about the impact of rate gaps on the Canadian dollar have not always materialized. For instance, in 2003, a substantial rise in the loonie did not lead to the expected decrease in inflation despite a significant rate spread between Canada and the U.S.

Overall, experts suggest that the economy has become more adept at managing currency risks and volatility, which could mitigate the potential negative impacts of a widening gap between Canadian and U.S. rates. As the situation unfolds, market participants will closely monitor the effects of diverging monetary policies on the Canadian dollar and inflation rates.