Canada’s central bank declaration of a pause might just be wishful thinking. This week, BMO warned investors that stubborn American inflation has the market pricing in 3 more hikes from the Federal Reserve. Canadian inflation might be lower than in the US, but the Bank of Canada (BoC) diverging from the Federal Reserve might not be practical. The resulting weakening of the loonie is likely to drive Canadian inflation higher, forcing the central bank to follow.
US Inflation Is Running Hot & It’s Going To Require Higher Rates
Inflation problems have moderated since last year, but they’re not moderating fast enough. US Core CPI, which excludes energy and food, isn’t decelerating as quickly as expected. At the same time, the economy is being flooded by positive indicators, such as a rise in job vacancies. All of this would be good news if inflation wasn’t multiples of the target rate, indicating the economy is overheated.
Despite surging rates, the economy isn’t slowing down—it’s taking the hikes in stride. This has resulted in the market pricing in 3 more 0.25 point hikes this year, taking the terminal rate to 5.25%-to-5.50%, according to BMO’s latest read. The bank notes this has helped launch the US dollar to new highs for the year.
Canada’s Higher Household Debt Means It May Tolerate Higher Inflation Than The US
Sure, but that’s the US, right? Canada has been performing better, taming inflation and with only minor economic cooling. When combined with the lofty household debt levels, the Governor explained he would like to pause and see how things develop.
BMO argues there’s two big reasons that Canada can diverge from the US when it comes to the key interest rates:
1) Household debt is much higher than the US, and shorter-cycles for mortgage rates leave the economy more vulnerable to rate hikes. The US saw households deleverge in the late 2000s, while Canadians are carrying some of the highest levels in the world.
2) Canada is handling wage and price pressure better. Its CPI highlighted the gap, as does the decline in job vacancies—dipping below 5%, shows the bank’s analysis. Wages are also failing to rise at the clip observed in the US, so it’s not providing wage-based inflation.
But there’s a big issue with the divergence, especially since the US is the largest trade partner. “True, the BoC can deviate a bit from the Fed, but the currency will act as a limiter on the extent of that deviation,” warns Douglas Porter, chief economist at BMO.
Diverging From The US Isn’t Practical Due To The Loonie
Porter argues a divergence between the two countries isn’t feasible for long due to currency. Since the US is Canada’s largest trade partner, and most commodities are priced in US dollars—a weakening loonie and cooling inflation are largely contrary factors.
“… the Bank may not have the luxury of staying on the sidelines if the Fed is still busily marching rates down the field, driving the loonie lower (and thereby sending imported costs flaring higher),” he explains.
Annual growth for import prices came in at 13% in Q4, which the bank notes is the first time in two years. “At least some of that import price inflation has been sparked by a 5% drop in the Canadian dollar in the past year,” he says.
All of this has so far only translated to slightly higher expectations for the overnight rate. The market is now pricing in another 0.25 point hike over the next year. At the same time, Government of Canada 5-year bond yields have been surging as the market sees more inflation risks than the BoC did just a few weeks ago.
“The five-year yield—important for the housing market—has vaulted above 3.6%, up by more than 70 bps just since the Bank [of Canada] signaled its pause less than a month ago.”
GOOD! INTEREST RATES TO THE MOON! SAVERS WIN!
Savers on? does the interest paid for a GIC are higher than the real inflation? please do your maths, and stop dreaming.
I’ll take a guaranteed 4.5 to 5% GIC rather than the stock market right now. Inflation is literally killing poor people. You should do some math.
You’re right for short duration GIC’s. If you take 3-5 year treasury or GIC and inflation is driven back down to 2% range in the next 12 months the saver wins.
The US deliberated in the late 2000’s. That never happened in Canada. One day their will be a delevaraging of Canadian debt and when it does happen their will be a lot of pain for consumers who have carelessly walked into this through poor advice and a lack of a plan.
Leverage is a great tool, part of the planning when you use leverage is to know when it is time deleverage, being addicted to low rates is dangerous and will inevitably end with poor outcomes for many people.
This outcome was obvious months ago, 7-9% motgage rates could well be on the cards
100%, I was obvious as soon as inflation started to rake hold a year ago.
you want to stop the recession then stop Trudeaus reckless spending. The bank of Canada is in bed with Liberal cronies who have zero regard for the hard working middle class tax paying families. This was planned.
If it does will turn canada into a banana nation, and before you throw your 80-90’s comparaison, no it’s not the same, is not the same cost of living not the same incomes, not the same cost of housing, etc…
does anybody really think canadian inflation is lower than the states. how many things can you say are cheaper than the states. the loonie will diverge from the greenback if we don’t follow with rate hikes. i hate to tell you but the loonie has been in the toilet for quite some time and it will go much further down in the future. all the lies and manipulation by the banks and statscan and the government are going to blow up everything. and for those who are unaware the interest rates today are still lower than the modern day average.
I was in the states for a month in 2 states, and yes over there the inflation is higher, food, and services, not so much in real state as here and also over there the salaries got a subtantial increase not like here, the US economy is a thousand times bigger and stronger than canadian economy as well the people have better net income, so that fueled their inflation,
We’ll be forced to increase our rates following a US fed increase or watch our inflation go higher; everything we import is priced in USD.
When the prime rate hits 7% and variable rate mortgages are between 8% to 9% only then will Canadian society really reign in spending as right now it is only an addiction to materialism that shows itself by way of debt loads .
Personally I am of the opinion and am in favour of rates at around 10% and believe the higher the better depending on ones intended objectives. And objectively I believe the higher the better!
Unfortunately the federal banks listen to the markets more than people being stretched at grocery stores. I believe the fed is doing some silent QE and the inflation rates are bogus. The rich rule and the people that are whining the most are the ones used to easy money in the markets. All the hack financial advisors out there better sharpen their pencils and get ready to do some work for a change.
Interest rates had been historically used to push currency higher to counter inflation. If US is increasing interest USD will continue to appreciate against loonie. This makes import expensive and Canadian inflation continues to go higher. Another way is for Canada to sell more of our resources to create demand for CAD, this will also push inflation down by our appreciating currency. However, the current government has been pushing away deals like LNG, BoC can only use interest rates to fight inflation. So, mortgage holders are made to sacrifice to fight this inflation.
I read these reports all the time and they are almost always wrong. It’s ridiculous to be honest. Every time it’s “oops, we had it wrong last month it’s gonna this this way now according to this random banker’s quotes. We would have been correct had this this and this not occurred”. Get real. The mortgage rate will be between 0.1% and 99%.
There. Fixed it for you.
BMO was on the money with almost every call they made, while they were ridiculed for thinking rates would have to rise above 2%.
Anytime someone goes with “I read reports all the time,” to dismiss the concept of reports means they have no clue what they’re talking about.
Perfect. They won’t stop until countless middle class families go bankrupt.
No sympathy here. Buying a home at today’s prices would have been foolish. Those who did priced me out of a home.
The middle class can still afford food. Those most in need are already in trouble!. Inflation needs to be stopped.
The ones who bought when prices were at their highest, FOMO buyers who drove the prices up will hopefully go bankrupt and let the economy settle back out where it should be. The people are still buying though. Waiting for it to stop.
This is what happens when you’ve got a trust fund baby running the country.
The loonie was trading at par with the US 10 years ago, and today the $US costs $1.36 CDN. The Canadian consumer is tapped out, and the economy is faltering. What next.
HIGHER INFLATION AND ESP. HIGHER INTEREST RATES WILL HELP IN REDUCING INCOME GAPS. WE HAVE HAD LOW INTEREST RATES FOR SO MANY YEARS AND IT HAS ONLY GONE ON TO ACCENTUATE WEALTH GAP. ASSET PRICES FALL IN HIGH INTEREST RATE ENVIRONMENT AND IT HELPS BRIDGE THE GAP.
You’re correct. years of free money has widened the wealth gap. Ridiculous stimulus during the plandemic didn’t help.
Could you explain how high Interest rates reduce the Wealth Gap? The only thing that improves my income is my employer. I haven’t had a raise in a year and I am sure if the interest rates go higher… I won’t get another one.
The Bank of Canada and Federal Reserve are foreclosing on the western economies due to the plunge in net oil. The western nations no longer have the energy resources to achieve positive gdp growth, and the Central Banks know that.
They have begun to foreclose on all debrt holders before establising anew system without debt based money creation.
To understand why, try this: https://stevenlawrencekayser.substack.com/p/peak-oil-happened-the-fiat-money
This will push middle class and families with kids into bankruptcies. After a brutal two years and now this. 4 years of mass. How do you expect anyone to have kids in Canada.
Free money from the treasury presses has to stop. Its not sustainable. Its not about the middle class with kids. Its about people living in tents. Dumb money has to learn. They still haven’t got the message yet.
This definitely seems to be the intentional controlled demolition of the Canadian economy. If people think the Bank of Canada is on the side of the plebian masses, they don’t understand the modern socialist state. The intention was always to return to a quasi-feudal system, with the debt serfs on the bottom and the priveleged few at the top, i.e Blackstone, Blackrock, etc.
Until all the people who drove this madness actually start defaulting we aren’t done with interest rate hikes. Illogical and uninformed purchasing behavior can’t be allowed to continue without consiquences, in addition we can’t let the retiring generation to cash out leaving the rest of us holding the bag. The proverbial bandaid should have been ripped off a decade ago and delaying it any longer will only mean the correction will be more severe. We have waited patiently working, saving, paying our dues and not feeling this insanity, bring on the interest rate hikes the more the better.