The Bank of Canada should move ahead of the US Federal Reserve in reducing interest rates – 03/26/2024

The Bank of Canada (BoC) is expected to move ahead of the U.S. Federal Reserve in its first rate cut, as tepid economic growth and slowing inflation create conditions for more rapid policy easing. borrowing rate, according to economists and analysts.

Canada's central bank may also need to make deeper cuts in the current cycle as the economy is much more sensitive to interest rates due to household debt, which, as a percentage of net disposable income, is the highest of the G7 countries, they warn.

Usually, a strong economy south of the border is good news for Canada, since about three-quarters of Canada's international trade is linked to the United States. But with Canada's economy growing 1% in the fourth quarter, compared to an annualized increase of 3.2% in the United States, the Bank of Canada could chart its own course.

“The Canadian economy has buckled under the pressure of higher interest rates…therefore it cannot keep up with the Fed,” said Simon Harvey, head of currency analysis at Monex, which expects a reduction of 25 basis points in June.

Money markets put the chance of a quarter-point cut at the BoC's June 5 meeting at 70%, and bets for a cut at the April 10 meeting have risen to 20% since Last week's data showed an unexpected slowdown in inflation.

The Fed is widely expected to cut rates for the first time at its June 11-12 meeting.

Aggressive rate cuts could help ease the burden on Canadian consumers who face high costs of living due to mortgage, auto loan and credit card payments. About a fifth of Canadian mortgage holders are expected to renew their contracts next year and the rate cuts could provide some relief.

At the same time, deeper and faster cuts could weaken the Canadian dollar, potentially reigniting inflationary pressures, according to foreign exchange market analysts.

Last week, the Swiss National Bank surprisingly became the first major central bank to cut interest rates due to slowing inflation, a move that caught markets off-guard. Others should follow.

Inflation in Canada fell to 2.8% in February, its lowest level in eight months, while consumer prices in the United States rose sharply, fueling expectations of an advance of the BoC on the Fed.

“Both headline and core inflation are a little colder in Canada, with the surprise decline in February widening an even wider gap,” wrote Douglas Porter, chief economist at BMO Financial Group, in a note last week.

“We have long believed that the Bank of Canada will outpace the Fed,” he added.

Despite low inflation twice, Bank of Canada Governor Tiff Macklem said underlying price pressures in the economy persisted and it was still too early to consider a reduction in the key rate. The bank's key interest rate has been at 5.0% since July.

However, according to economists and analysts, when the Bank of Canada begins to cut rates, the country will need deeper reductions than its neighbor.

Karl Schamotta, chief strategist at Corpay, said: “Canada is seen cutting rates more aggressively and over a longer period of time.”

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