Mar 23, 2023
How will the Bank of Canada weigh the U.S. Fed rate decision?
U.S. Federal Reserve will probably stop raising rates fairly soon: Former Kansas City Fed president
A lot has changed in the global financial landscape since the Bank of Canada decided to pause its interest rate hiking cycle on March 8.
U.S. banks have collapsed, a similar crisis was narrowly avoided in Europe and the U.S. Federal Reserve on Wednesday went with a smaller rate hike than it had previously forecast as the banking turmoil complicated its fight against inflation.
Economists told BNNBloomberg.ca that the banking crisis to the south and its influence on the U.S. Fed’s monetary policy plans may give the Bank of Canada more confidence in its decision to hold its key interest rate at 4.5 per cent – though anything could change before the next policy decision on April 12.
U.S. VS CANADIAN MONETARY POLICY
Some economists had raised concerns weeks ago that the Canadian dollar could take a hit if the U.S. Federal Reserve kept tightening after the Bank of Canada pulled back, complicating its battle with Canadian inflation.
Josh Nye, senior economist at the Royal Bank of Canada, said that narrative has changed with the banking developments and latest Fed decision, and the changes are likely reassuring for Canada’s central bank.
The Fed’s decision to raise rates 25 basis points and potentially hike one more time would leave the central interest rate gap between the two countries in a historically normal range, Nye said.
“(It puts) a lot less pressure on the Bank of Canada to get back to raising interest rates, because the Fed looks like it's pretty close to a pause as well,” Nye told BNNBloomberg.ca in a telephone interview.
Jimmy Jean, vice-president, chief economist and economic studies strategist at Desjardins Group, said he sees the Bank of Canada as “being quite independent at this stage, relative to what the Fed does,” noting that the U.S. typically goes further than Canada in its tightening cycles.
Any risks to the Canadian dollar value aren’t the Bank of Canada’s main concern, Jean added.
“It pays attention to the Canadian dollar, but it's not the prime consideration in its decision making. It's really if the broad macro situation is really affected,” he said in a telephone interview.
Nye also noted that a tightening credit situation in the U.S. in response to the banking sector developments “does some of the Fed’s work for it” in slowing the economy – and while the same dynamic isn’t necessarily reflected in Canada, big changes in the U.S. economy still impact its northern neighbour.
“This does slow the U.S. economy a bit more, they're very important trading partner for Canada, so again, another reason why the Bank of Canada is probably more comfortable remaining on the sidelines,” he said.
Jean pointed to inflation trends, the Bank of Canada’s main foe in its last year of interest rate policy changes, as offering a balance to the recent instability in the world financial sector.
Statistics Canada figures from February published this week suggest inflation is going down, though at 5.2, it’s still far from the Bank of Canada’s two per cent target.
“(Inflation) has been going perhaps more in the right direction than it has in the U.S.,” Jean said. “I would tend to think that what's happening is comforting the Bank of Canada in its decision to pause”
Many have pointed to interest rate hikes as one culprit behind the collapse of Silicon Valley Bank this month, illustrating the difficult path central banks are walking as they try to set policy to bring down inflation.
Jean said the Bank of Canada and the Federal Reserve appear to be balancing both issues – the banking crisis and inflation – as separate concerns. Recent coordinated moves by central banks, including Canada’s, to gain access to daily lending facilities with U.S. dollars shows the Bank of Canada is boosting its tools to handle further banking developments, he added.
“I think they're going to play to the idea that financial stability is one thing, they have tools to address that, but price stability is another thing and they have to keep at it and they have to make sure that one objective doesn't run counter to the other one,” he said.
HOW LONG WILL THE CENTRAL BANK HOLD?
The world is still assessing the fallout from the financial system upheaval, but economists said it could impact the timeline of the Bank of Canada’s interest rate cycle.
Nye said he’s still predicting Canada’s bank will start cutting rates in early 2024, and recent banking developments make further increases this year more unlikely.
“They set a relatively high bar already for resuming rate hikes,” he said. “I think perhaps the best we can say at this stage is that what's gone on recently probably raises that bar even more for the Bank of Canada.”
Jean said he predicts the Bank of Canada will be “in wait and see mode” as the impact of the bank chaos plays out, and it could mean earlier rate cuts if Canadian consumers and businesses take hits in the aftermath.
“That (rate) pause will continue to be conditional, but it's going to not just be conditional on inflation behaving, but also conditional on things not going out of control in the banking system, in which case, the case for eases would be also warranted,” he said.