Central banks gear up for a big September

Are the Bank of Canada and Federal Reserve set to increase interest rates again?

September is set to be another significant month for the Canadian and US economies, with both countries’ central banks preparing to reveal their latest decision on interest rates and a slew of data forthcoming on how well each economy is withstanding their current challenges.

While a much-discussed crash has so far been avoided on both sides of the border, there are some indications that a series of aggressive rate hikes by the Bank of Canada and Federal Reserve are beginning to weigh against their economies’ strength.

In Canada, the unemployment rate ticked upwards to 5.5% in July as the economy trimmed 6,400 jobs – and the latest GDP data suggested that growth slowed to 1% in the second quarter of 2023 amid waning consumer spending.

The US, meanwhile, is seeing hopes rise of a so-called “soft landing” for the economy, although job growth in July fell below expectations despite a drop in the unemployment rate.  

RE/MAX Canada president Christopher Alexander explained that higher rates have led to reluctant buyers and sellers, causing a standstill in inventor.

Could the Bank of Canada and Fed start to diverge on rate hike policy?

As the Bank of Canada prepared to hit pause on its rate-hiking trajectory in spring of this year, much discussion focused on the possible repercussions for the loonie if Canada’s central bank stopped increasing rates while the Fed showed little signs of slowing.

Unexpectedly persistent inflation and housing market activity helped convince the Bank to return to its policy of rate jumps in June and July, with its benchmark rate now sitting at a 22-year high of 5.0%.

The Fed’s intent on interest rates will continue to be closely scrutinized by the Bank of Canada in the coming months, according to a top economist, although the prospect of the gap widening between the Bank’s benchmark rate and the Fed’s funds rate appears – for now – remote.

“I’m sure Mr. [Tiff] Macklem [Governor of the Bank of Canada] would like to exist on an island, but it’s unfortunate to admit that our economy is quite dependent on the American economy,” Francis Gosselin (pictured top), consulting economist at nesto, told Canadian Mortgage Professional. “So I’m pretty sure they are looking very thoroughly at what the Fed is doing and urge our own policy.

“Surprisingly, although there’s a bit of a gap now, and it’s been that way for a while between the Canadian and American policy rate, we haven’t seen a significant shift over the long run on interest rates.”

The Fed’s funds rate currently sits at a range of 5.25% to 5.5%, a full 50 basis points higher than the Bank rate, but there seems little chance of either central bank diverging dramatically from the other’s approach in the near future.

“The interest rate is only one of the factors and although you have a half-point gap between Fed and Bank of Canada policy rates, it’s remained steady,” Gosselin said. “So if the gap should really spread – if there was at one point a one-percentage-point difference – then that might have an impact on the exchange rate.

“But I think in the short term, it’s probably going to remain around that window, 72 to 76 cents or something like that.”

Could the 2% target for annual inflation be revised upwards?

Both the Bank of Canada and Fed have remained steadfast in their desire to bring inflation down to 2%, with neither institution ruling out further rate hikes despite the fact that the consumer price index has slowed significantly in both countries over the past year.

That’s sparked some debate over whether 2% is too low a target – but Gosselin said now is not the time to consider making big changes.

“It’s an agreed-upon figure, an international standard [with] the European Central Bank, the Fed – I think it would be strange for us to adopt another stat,” he said. “I think it has its merits, but I don’t think when times are hard, it’s time to renegotiate your target.

“Let’s reach 2%, make sure it’s there for a year or two, and then we can have that conversation. But right now, it’s kind of disingenuous to have a moving target.”

CMP

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