With the Bank of Canada preparing for his final interest rate decision of 2024, experts warn that the Canadian dollar, in decline, could well fall further if the central bank makes the significant reduction expected by the markets.
The Bank of Canada is widely expected to lower its benchmark interest rate, currently at 3.75 percent, in a fifth straight decision on Wednesday.
But the scale of the central bank’s cuts remains a matter of debate, with markets and many economists now arguing for a larger cut, of 50 basis points, matching the cut seen in October.
Money markets increased the probability of excessive action to 80 percent after Friday’s November jobs report. showed a larger than expected rise in the unemployment rate to 6.8 percent last month.
The weak jobs numbers were enough for BMO to change its own decision on Wednesday’s rate decision, with the bank’s economists now expecting a half-point cut instead of the 25 basis points usual. TD Bank is the only major Canadian bank to request a quarter-point cut this week.
But Friday’s jobs report also had a dampening effect on the Canadian dollar.
The Canadian dollar lost about half a cent against the U.S. greenback on Friday, continuing a dismal few months for the loonie.
As of Monday evening, the loonie was at around 70.5 cents against the US dollar, about four cents lower than at the end of September. The Canadian currency is hovering just above its lowest level in 4.5 years against its American counterpart.
Among the factors proposed by experts to explain The decline of the loonie is due to the re-election of Donald Trump and the protectionist trade policies of the president-elect..
But Nathan Janzen, deputy chief economist at RBC, points out that the divergence in key rates between the Canadian and American central banks constitutes the main obstacle to the loonie.
And he sees this gap widening in the months to come.
“This will tend to put downward pressure on the value of the Canadian dollar relative to the U.S. dollar,” he told Global News.
The Bank of Canada has so far cut interest rates by 1.25 percentage points since the start of its easing cycle in June, one of the fastest and most recent rate cuts early among the world’s central banks.
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While the U.S. Federal Reserve made a splash with its first half-percentage-point cut in September, the south-of-the-border central bank has already slowed its pace with a 25-basis-point cut last month.
The reason the Bank of Canada has had to cut spending more sharply is due to the more pronounced weakness in the Canadian economy, while the U.S. economic engine holds strong, Janzen says.
In addition to November’s weak jobs report, recent data has showed that the Canadian economy did not meet the expectations of the Bank of Canada in the third quarter of the year. While pricing pressures have shown a bit of stickiness latelyThis economic weakness is expected to continue to exert disinflationary pressures on the Canadian economy as a whole.
“This justifies a Bank of Canada that is more aggressive than the U.S. Federal Reserve in terms of additional rate cuts,” Janzen said.
A weak loonie has many consequences for Canadians. Not only do Canadian travelers face more expensive trips across the United States with their dollar no longer as strong as before, but domestically, goods imported from the United States will be more expensive for businesses.
Even BMO, which increased its call for a deeper cut last week, warned in a note to clients Friday that there are risks to the Canadian dollar from a 50 basis point decline that ” should not be ignored.
Benjamin Reitzes, director of Canadian rates and macroeconomic strategist at BMO, wrote that if the loonie were to be “hammered” by a sharp rate cut, consumers would do it. feel it quickly at the grocery store.
“Grocery, which is a particularly sensitive sector for Canadians, would see almost immediate pressure as winter brings an increase in fresh food imports,” Reitzes wrote.
Due to pressure on imports, the weak Canadian dollar can fuel inflation, jeopardizing the Bank of Canada’s progress in fighting inflation if the exchange rate continues to weaken.
“The potential impact on inflation and inflation expectations should not be overlooked,” Reites wrote. “And be careful, if the depreciation of the Canadian dollar accelerates, it could be difficult to stop it. »
Will the weakness of the loonie slow down the Bank of Canada?
Bank of Canada Governor Tiff Macklem has said in the past that while the central bank sets monetary policy for the Canadian economy independently of other countries, there is a “limit” to the extent to which rates Directors may deviate from those of the US Fed because of this relationship. .
“We know that when the Canadian dollar weakens, the cost of imports increases, which can lead to higher prices for consumers, which runs counter to the policy objective of the Bank of Canada,” explains Janzen.
But Janzen doesn’t expect the Bank of Canada to be intimidated by a bigger cut of 50 basis points on Wednesday, due to fears for the loonie.
Across the entire consumer spending basket, he says only about 10 per cent of the typical Canadian’s spending is on imported goods, excluding motor vehicles. The remainder of this spending is largely devoted to services, including housing.
Janzen says that while the remaining 90 percent of the typical basket still faces significant disinflation from the slowing Canadian economy, the central bank will likely tolerate a slight increase in pressure from the relatively small proportion of imported goods in Canadian budgets.
In other words, the weakness of the loonie does not yet jeopardize the Bank of Canada’s anti-inflation mandate, says Janzen.
While markets have effectively priced in a 50 basis point cut from the Bank of Canada on Wednesday, Janzen expects the loonie to not fall much further this week if the central bank achieves the expected cut.
But he also believes that markets are underestimating the extent to which divergences between the Bank of Canada and the US Fed are likely to widen in the coming months, with the latter likely interrupting its easing cycle sooner in a context of continued economic strength south of the border.
This means that the loonie should fall further in 2025, according to Janzen.
There is a silver lining to the early start of the Bank of Canada’s easing cycle, which is that the anticipated recovery may be closer on the horizon, he adds.
RBC forecasts that the Canadian economy will rebound in the second half of 2025, as the lagged effects of previous interest rate cuts begin to provide some relief to consumers and businesses. Janzen notes, however, that continued “uncertainty” around US trade policy is likely to have further implications for the exchange rate between the two currencies.
But once the Bank of Canada’s key rate reaches neutral levels and the gap with the US Fed’s rates stops widening, he sees better days ahead for the Canadian dollar.