Bank of Canada can diverge from Fed on rates without stoking inflation, National Bank says
The Bank of Canada’s policy interest rate may fall 100 basis points below that of the Federal Reserve’s “without policymakers batting an eye,” according to economists at one of the country’s largest lenders.
That’s because the Canadian central bank can ease rates more aggressively than markets are currently pricing before it would see a “material” weakening of the loonie, National Bank of Canada economists Taylor Schleich and Warren Lovely said in a report to investors Thursday.
Overnight swap markets are pricing in about 55 basis points of cuts in Canada by year end, compared with 35 basis points in the United States. The majority of economists in a Bloomberg survey expect the Bank of Canada’s first cut to happen in June after price pressures have cooled in recent months.
Schleich and Lovely pushed back against the argument that the Bank of Canada’s benchmark rate is tethered to the Fed’s because a weaker currency means inflation in imported goods.
“We don’t deny that a weaker C$ boosts import prices but the pass-through to consumer prices is smaller than widely appreciated,” they wrote, adding that the central bank’s research and model suggested that a 10 per cent loonie shock might add 25 to 30 basis points to core inflation.
Recent episodes of Canadian dollar weakness “haven’t coincided with outsized inflation either, outright or vis-à-vis the U.S.,” Schleich and Lovely said.
A larger Bank of Canada-Fed policy rate gap than the current 50 basis points isn’t uncommon, they said. Nearly a quarter of the time since 1995, the Canadian central bank has set its policy rate more than 50 basis points below the Fed’s.
Their view implies that the Bank of Canada can easily cut its policy rate to 4.5 per cent from the current
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