The U.S. Federal Reserve’s decision to hold interest rates steady as the Bank of Canada reignites its rate-hike cycle could be good news for the Canadian dollar and the inflation fight north of the border, according to a BMO economist.
Benjamin Reitzes, BMO’s managing director of Canadian rates and macro strategist, tells Global News that even temporarily divergent rate paths from the central banks would be a boon for the loonie, which in turn could limit how restrictive the Bank of Canada needs its policy rate to be.
The U.S. Fed’s decision to leave rates unchanged on Wednesday — its first pause after 10 consecutive hikes — comes a week after the Bank of Canada came off the sidelines to increase rates by another quarter percentage point.
Some economists and big banks, including BMO, are calling for another rate hike from the Bank of Canada in an upcoming decision in July. Market odds are leaning that way as well, Reitzes notes.
The Fed also signalled two small rate hikes could be in the cards for the rest of the year following its pause in June.
Central banks on both sides of the border are “almost entirely” dependent on the kinds of economic data they see in their inflation and labour market reports over the next few months, Reitzes says.
TD Bank senior economist James Orlando said in a note to clients on Wednesday that if the U.S. economy slows according to TD’s forecasts in the latter half of the year, it could be enough to keep the Fed on pause indefinitely — despite the suggestion of additional hikes.
If the Bank of Canada delivers on expectations and hikes rates in back-to-back decisions while the U.S. Fed moves off to the sidelines, Reitzes says the differential between those two rates will be good news for the loonie — and by extension, Canada’s inflation fight.
When the Bank of Canada’s policy rate moves higher relative to the Fed’s, that gives the Canadian dollar a boost relative to its U.S. counterpart, Reitzes explains. Global investors tend to flock to currencies backed by higher central bank rates, driving up the demand and value of that currency.
The Canadian dollar hit a four-month high ahead of Wednesday’s rate decision from the U.S. Fed, according to Reuters, which said strength in oil prices was giving another boost to the loonie. The Canadian dollar held steady at around 75 cents to the U.S. dollar Wednesday afternoon following news of the pause.
That’s great news for Canadians who are vacationing south of the border this summer, as a stronger loonie increases their spending power, Reitzes says.
But it also affects the costs of imports from the U.S., which can take some of the pressure off inflation, he adds.
“Things like food prices and other imported goods would come down a little bit, help battle inflation that much more,” Reitzes says.
That can add some extra fuel to the Bank of Canada’s efforts to bring inflation back down to its two per cent target, Reitzes says, and may mean it can limit how high interest rates need to go or how long they have to stay there.
“At the end of the day, if you get the Canadian dollar strengthening sufficiently, maybe it means the bank needs to do that much less to bring inflation down.”