In this week’s economic update, we are discussing the potentially diverging interest rate policies between Canada and the U.S. It is expected that the Bank of Canada will approach its interest rate policy more aggressively, including a half a percent cut expected this week. We’ll examine what’s driving this policy, and how a divergent Canadian interest rate policy from the U.S. could impact the Canadian dollar.
We are also sharing a recent article from RBC Economics discussing the anticipated interest rate cut and the factors behind that decision.
Lastly, we are proud to highlight our upcoming sponsorship of the 1st Annual NovemBurger event, in support of the United Way Guelph Wellington Dufferin.
Economic Update
North American equity markets continue to push to record highs, bolstered by a promising start to the U.S. third-quarter earnings season. The results from major banks signal a healthy U.S. consumer, with spending supported by a resilient labour market despite some softness among lower-income households. Historically, periods of declining interest rates – especially amid a “soft landing” scenario where the economy continues to grow – create favourable conditions for investment returns. Below, we discuss the potential for a more meaningful divergence in the path of interest rates in Canada and the U.S., with implications for the Canadian dollar.
Decelerating inflation and less intense pricing pressures
Canada’s inflation report for September was released over the past week, and it decelerated more than expected, with the overall Consumer Price Index (CPI) dipping below the Bank of Canada’s (BoC) 2% target for the first time since early 2021. Falling gasoline prices contributed to much of the decline, so the “core” inflation measure, which removes more volatile categories such as energy and food, held steady above 2%. Meanwhile, housing-related categories remained the largest contributors to inflation, but mortgage interest costs and rent pressures also continued to recede from high levels. Also encouraging, the breadth of inflation narrowed further towards pre-pandemic norms, suggesting that an increasing amount of every-day goods and services are seeing less intense pricing pressures.
Aggressive interest rate policy expected in Canada, potential less aggressive in the U.S.
In recent months, the Bank of Canada has telegraphed a shift in its priorities. More specifically, it is increasingly turning its attention to ways it can better support economic growth given the declines witnessed to date with inflation. It has already cut its policy rate three times since the summer. Moreover, given recent inflation figures, markets now expect the Bank of Canada to approach its interest rate policy more aggressively. The consensus view is the Bank will cut interest rates by half a percent when it meets within the next week. And some economists, including at our firm, expect Canadian policymakers to remain aggressive heading into the end of the year and into next year. Meanwhile, U.S. economic indicators continue to be sturdier, as evidenced by the most recent retail sales figure released over the past week that suggests the consumer remains healthy. While the U.S. Federal Reserve has also started to cut interest rates and is expected to continue to do so, there may be less of a case for the kind of aggressive approach that is expected from the Bank of Canada. At some point next year, there is the potential that interest rates in Canada could sit meaningfully below interest rates in the U.S.
Divergent rates could weaken Canadian dollar
Interest rate differentials – the difference between short-term interest rates between countries - often influence currency flows, as funds gravitate towards higher-yielding currencies, strengthening their value relative to lower-yielding ones. In recent weeks, this trend has propelled the U.S. dollar higher against other major currencies, including the Canadian dollar. The Canadian dollar could experience further downside if the interest rate divergence between the U.S. and Canada widens, as some are predicting.
Summary
We are mindful of the risks of further downside to the Canadian dollar should interest rates meaningfully diverge. But we also see the potential over the next few years for lower interest rates to stabilize and improve the growth outlook in Canada by providing some relief to consumers and businesses. After all, the Canadian economy is sensitive to interest rates, and arguably more so than the United States. For now, we continue to view our U.S. dollar exposure in our clients’ portfolios as offering important diversification and protection in today’s environment.
BoC expected to make its own 50 basis point interest cut this week
The Bank of Canada is expected to accelerate the pace of interest rate cuts with a 50-basis point reduction to the overnight rate to 3.75% from 4.25% on Wednesday.
The BoC has already lowered interest rates earlier than most advanced economy central banks, with three consecutive 25 bps cuts since June. Yet, the economic backdrop has continued to soften, and risks to inflation look increasingly tilted to the downside of the BoC’s 2% target.
In this article from RBC Economics Forward Guidance, you can learn more about what’s driving this potential change in policy by clicking this link.
1st Annual NovemBurger, in support of the United Way Guelph Wellington Dufferin
We’re proud to announce that we will be the presenting sponsors of the 1st Annual NovemBurger, in partnership with the United Way Guelph Wellington Dufferin.
Novemburger will bring together the power of food and the power of giving back – it’s all about supporting local!
Funds raised through NovemBurger will support food insecurity programs across Guelph, Wellington County & Dufferin County – so starting on November 1st, you can grab a burger, support a local restaurant and give back all at the same.
You can learn more and find the participating restaurants by clicking here.
As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.
