Market Sees Historic Divergence As Bank Of Canada And Fed Go Separate Ways

Investors started to analyze the sensitivity of Canada’s economy to higher interest rates.

They further argued that there will be a significant difference between the tightening campaigns of the Bank of Canada and the U.S. Federal Reserve.

This comes as the Bank of Canada halts its interest rate hikes. As the result, investors are expecting a historical gap between the two central banks.

For a considerable time, experts have contended that when it comes to increasing interest rates, Canada’s economy is more vulnerable than the economy of the United States.

This is because Canada has a higher proportion of variable-rate mortgages. Moreover, a larger share of its economy is composed of export-oriented industries that are heavily reliant on foreign demand.

Thus, any changes in interest rates have a significant impact on the borrowing costs of Canadians. It seems that the market has already adjusted its pricing to reflect this expectation.

According to analysts, recent major economic data has provided evidence to support that there will be a wider gap between the interest rate hikes in Canada and the United States.

Canada Has Managed to Control the Inflation

In January, the rate of inflation in Canada decreased by a larger amount than anticipated, dropping to 5.9%.

As far as the country’s GDP growth is concerned, it did not experience any growth in the final quarter of the year, due to its sluggishness in the interest rate sector.

Apart from that other significant macroeconomic factors such as consumer investment, corporate capital generation, and employment also show sluggish progress.

Lower Interest Means Higher Pressure on Canadian Dollar

The Canadian dollar has been under pressure against the US dollar due to a reduction in the expected peak for Canadian interest rates.

On Wednesday, the currency’s value dropped to its lowest point in four months, reaching 1.3815. This came after the BoC decided to keep its policy rate rigid at 4.50%.

With this announcement, the Bank of Canada has become the first bank that has decided not to bring any further strictness to the country’s monetary policy.

The cost of imported goods for Canadians may increase, which could contribute to inflationary pressures if the currency stays weaker.

Experts are pointing out that the Canadian economy is sensitive, hence the lower interest rates can drag inflation back to the market.

Compared to BoC’s decision, the U.S Federal Reserve’s Chairman Jerome Powell on the other hand decided to further increase the interest rate for a longer than an extended period.

It has been expected that the Bank of Canada’s policy rate is anticipated to reach its highest point at approximately 4.75%.

According to analysts, there is a possibility that the Bank of Canada may have a limit on how much difference in interest rates they will permit.

Many economic experts have already suggested that the Bank of Canada needs to take strict actions to cope with the decline in the price of its currency.

But as the things stand, BoC has decided not to raise the interest rate. The Canadian dollar has already been weaker against the USD.

The U.S Federal Reserve’s Chair increasing the interest rate would give further upward momentum to the USD.

This shows that the short dollar will further increase the pressure on the Canadian dollar. The higher the divergence the higher the CAD will plunge in terms of price.

Moreover, if the bank of Canada sticks with its current policy then inflation will once more become a mounting problem for the country’s economy.

Hence BoC needs to keep up with the Feds. On the other hand, stock and commodity market investors have appreciated this decision.

The decline in interest rates would eventually give momentum to the equity market.

Currently, the Canadian economy is growing at 25% which is higher than the U.S. economic growth rate. But if inflation occurred the numbers can experience a quick decline.