As the Bank of Canada prepares to lower its key rate, Canada can afford to have lower interest rates than in the United States without running the risk of reviving inflation, according to the economist in head of Desjardins.
“Canada is not chained to the Fed,” said Jimmy Jean, when updating Desjardins’ economic forecasts. He recalled that Canada and the United States have had divergent rates six times since the year 2000.
The last time was in 2016, when the fall in oil prices forced the Bank of Canada to cut rates while the US Federal Reserve was preparing to raise them.
A weaker Canadian dollar means higher prices for goods imported into Canada, from oil to oranges to goods and services produced abroad, which could fuel inflation again.
This is an unlikely scenario, according to Jimmy Jean. “The sensitivity of inflation to the Canadian dollar is very low,” he explained. “It would take a very strong devaluation of the Canadian dollar for a long time to create an inflation problem.”
The only scenario that could slow down the fall in Canadian rates, according to him, is if the weakness of the dollar strongly stimulates exports and creates overheating of the Canadian economy. This is another unlikely scenario, believes Jimmy Jean.
The interest rate differential between Canada and the United States is an important determinant of the value of the Canadian currency, but it is not the only one. “We must keep in mind that several other variables influence the Canadian dollar such as the price of oil and risk sensitivity, which have even more weight.”
The decline in interest rates which should begin this week may therefore continue, according to Desjardins, which sees the Canadian key rate at 4% at the end of the year and at 2.5% at the end of 2025.
Both the Canadian and Quebec economies remain in a state of great weakness. Halfway through the year, Desjardins forecasts growth of 1% in Canada in 2024 and only 0.7% in Quebec.