There’s a limit to how much interest rates in Canada and U.S. can diverge: Macklem

OTTAWA — Canadian interest rates don’t have to match U.S. or global rates, Bank of Canada governor Tiff Macklem says, but they need to stay within a certain ballpark.

Macklem made the comments while testifying before the House of Commons finance committee alongside senior deputy governor Carolyn Rogers on Thursday.

“Our interest rates in Canada don’t need to be the same as the U.S. rate or global rates. But there is a limit to how far they can diverge,” Macklem said. 

“We’re not close to that limit.”

The Bank of Canada is widely expected to begin lowering its policy rate in the coming months, while forecasters expect the U.S. Federal Reserve to take longer.

The Bank of Canada’s key interest rate is currently sitting at five per cent, which is below the Federal Reserve’s target range for the funds rate of 5.25 to 5.5 per cent.

BMO chief economist Douglas Porter said the reason interest rates can’t diverge too much is because that would lead to a significant depreciation in the Canadian dollar relative to the U.S. dollar.

That would make imports from the U.S. more expensive and disrupt trade if there are big currency swings, he added.

Porter said the Bank of Canada has to tread carefully because a divergence in rates could also lead to an overreaction in the foreign exchange market, which would further depreciate the Canadian dollar. 

“There is a risk that the foreign exchange markets could overshoot. So in other words, overreact to something that maybe Canada would do,” he said. 

The U.S. Federal Reserve held interest rates on Wednesday and signalled it won’t cut them until it is more confident that the annual inflation rate is headed back to the two per cent target.

The ongoing strength of the U.S. economy has made it a global outlier. Inflation has also been stickier south of the border. 

“In recent months, inflation has shown a lack of further progress toward our two per cent objective,” said Jerome Powell, the chair of the Federal Reserve.

“It is likely that gaining such greater confidence will take longer than previously expected,” he added. 

In contrast, the Bank of Canada has been encouraged by recent progress on the inflation front. 

Core measures of inflation, which strip out volatile prices, have eased over the last few months.

Canada’s annual inflation rate was 2.9 per cent in March, below the U.S.’s 3.5 per cent.

Macklem has said that the Bank of Canada is seeing the right trends to begin lowering interest rates, but it wants to see those trends sustained for longer.

Forecasters widely expect the Bank of Canada to begin lowering its policy rate in June or July.

Porter said the Bank of Canada has some room to cut interest rates ahead of the Federal Reserve.

“Our view is that the (Bank of Canada) can certainly cut one time without the Fed. They may even be able to cut two times as long as there is the expectation that the next move by the Fed will will be to cut,” Porter said.

“I think that’s about as far I think the (Bank of Canada) can go without causing some pretty serious stress on on the Canadian dollar.”

This report by The Canadian Press was first published May 2, 2024.

— With files from The Associated Press.

Nojoud Al Mallees, The Canadian Press