The governor of the Bank of Canada, Typh McLem, spoke at a news conference in Ottawa on June 9. PATRICK DOYLE / The Canadian Press
The US Federal Reserve has just raised the bar for using interest rates to attack inflation. The Bank of Canada now has a few short weeks to decide whether to follow.
That is how it should be done.
In a historic interest rate decision on Wednesday, the Fed raised its federal interest rate by a whopping 75 basis points – three-quarters of a percentage point – to a range of 1.5% to 1.75%. Usually, interest rate increases in the Fed are made in steps of 25 basis points; this increase was three times the norm and the largest in nearly three decades.
But the even bigger news is that the Fed is just beginning. At a press conference after the announcement of interest rates, Fed Chairman Jay Powell said the next central bank raise in July looks set to be tossing a coin between 50 basis points and another 75. Members of the Federal Open Market Committee, which sets the Fed’s key value interest rate – now forecast that the rate will reach nearly 3.5% by the end of this year, an increase from their March forecast of just under 2%.
The dramatic escalation has prompted other central banks to warn, not least the Bank of Canada – which has so far been well ahead of the Fed in tightening monetary policy. The Fed suddenly surpassed its smaller neighbor, which raised its own key interest rate to 1.5% in early June. And a notice was issued that he would continue to jump. This time at the accelerated interest rate that the Fed has now drawn, it may impose some more difficult questions on the Bank of Canada.
The Bank of Canada generally does not feel too compelled to keep up with the Fed. But in this case, he has both the motive and the opportunity to keep up with Jones with his own increase of 75 basis points in his next bid in mid-July.
Bank of Canada will need more than difficult talks to show that efforts to tackle inflation work
Although the bank would never acknowledge it, maintaining the Canadian exchange rate above that of the United States would be generally favorable to the Canadian dollar, as higher interest rates attract foreign exchange investors. Officially, the Bank of Canada is not interested in the dollar exchange rate; but he knows very well that stronger moons mean lower prices for Canadian consumers of imported goods. In other words, a strong dollar is a useful tool for easing inflationary pressures, at least in the relatively near future.
The Fed also knows this, and he certainly doesn’t mind that his increasingly aggressive interest rate stakes a fire under the greenback. The Canadian dollar has performed better than most of its US counterpart in recent weeks, in part due to the Bank of Canada’s own acceleration in interest rate hikes (up 50 points in April and June). The bank is likely to see value in restoring this competitive advantage.
In fact, the Bank of Canada already seemed prepared for its own increase of 75 basis points long before the Fed’s dramatic move on Wednesday. Raising its interest rate by 50 points in early June, the bank said it was “ready to act harder if necessary” to reduce inflation. At a press conference the next day, Deputy Governor Paul Baudry said that “stronger” means that the bank is ready to make both larger individual interest rate increases and ultimately raise interest rates to a higher peak.
The governor of the Bank of Canada, Typh McLem, and the chairman of the Fed Powell have said they want to push their interest rates into what they see as neutral territory – where interest rates neither stimulate nor hinder economic activity – as quickly as possible. For both central banks, this is estimated at somewhere between 2% and 3% – for convenience, then call it 2.5%.
With the Fed already setting a precedent of 75 points, this opens the door for public and financial market psychology for Mr McLeom to take a similar leap in the next July 13th interest rate set for the bank, which Canada will receive. very close to neutral.
Of course, he will be able to see a few more key economic points before he and his colleagues make that decision. The most important will be the data on inflation in May, which should be published next Wednesday.
Mr Powell cited last week’s US inflation figures, which exceeded the Fed’s estimates, as the main reason for the central bank’s interest rate hike by 75 points. Mr MacLeam may receive a similar green light from Canadian data next week.
The Canadian central bank has repeatedly spoken about the potential to pause its gains once it reaches neutral to assess the impact of higher interest rates on the economy, although it has suggested that interest rates may need to exceed neutrals for some time. to cool excess demand. But the Fed was clear on Wednesday that it expects to break the neutral point by the end of the year and rise even higher next year.
The Canadian economy does not have as much demand or inflation as the US economy. While Mr. McLeom and his team may be motivated to be neutral before the Fed, they will have to decide how far they want to follow the Fed after that point – and how long they can wait to make that decision.
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