Analysts have long argued that Canada's economy is more
sensitive to interest rate hikes than the U.S. economy, pointing
to the higher debt loads of Canadians after they participated in
a red-hot housing market in recent years and the shorter
Canadian mortgage cycle.
But now some major economic data has given substance to that
view and supports the market's recent move to price in a wider
gap between the end points for interest rate hikes in Canada and
the United States, say analysts.
Canadian inflation slowed more than expected to 5.9% in
January and gross domestic product was flat in the fourth
quarter, held back by weakness in the interest rate-sensitive
parts of the economy, including housing investment as well as
business spending on machinery and equipment.
A lower expected peak for Canadian rates has pressured the
Canadian dollar against its U.S. counterpart. The
currency hit a four-month low on Wednesday at 1.3815, or 72.39
U.S. cents, after the BoC left its benchmark interest rate on
hold at 4.50%, becoming the first major central bank to suspend
its tightening campaign.
A weaker currency could drive up the cost of imported goods
for Canadians, adding to inflation pressures.
"The Canadian economy is just far more sensitive to interest
rates because of factors like the crazy amount of debt-to-income
that we've got, because of our overheated housing market," said
Jay Zhao-Murray, a market analyst at Monex Canada Inc. "The
transmission channels of monetary policy are more effective in
Canada than in the U.S."
Contrasting with the BoC, Fed Chair Jerome Powell delivered
a message this week of higher and potentially faster rate hikes.
Money markets expect the BoC's policy rate to peak at about
4.75% this year, or roughly 90 basis points below the expected
end point of the Fed. Canadian rates have peaked below U.S. rates in the three
major tightening cycles since the start of the millennium, with
the gap ranging between 50 and 75 basis points.
"Poring over the national accounts, it's increasingly clear
that interest-sensitive demand has wilted in Canada," Warren
Lovely and Taylor Schleich, strategists at National Bank of
Canada, said in a note after the recent GDP data.
Their work shows that interest rate-sensitive demand in
Canada's economy was 26% of final domestic demand at the start
of the current rate hike cycle, one of the highest shares on
record, compared with 21% for the United States.
Still, there could be a limit to how much interest-rate
divergence the BoC will allow, say analysts. Last October,
Governor Tiff Macklem warned that the bank might tighten more
aggressively in response to a weaker currency after the loonie
hit a two-year low of 1.3977.
"If the spread diverges any further there is going to be
further depreciation of the Canadian dollar and that will feed
in to eventually inflation in this country," said Royce Mendes,
head of macro strategy at Desjardins.
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
INSTANT VIEW-Bank of Canada holds rate after aggressive
tightening cycle Bank of Canada leaves rates unchanged, sees inflation falling as
forecast ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
(Reporting by Fergal Smith in Toronto
Editing by Matthew Lewis)
By Fergal Smith
TORONTO, March 9 (Reuters) - As the Bank of Canada
pauses its interest rate hikes, investors are betting that the
sensitivity of Canada's economy to higher borrowing costs will
result in a historically large gap between the tightening
campaigns of the BoC and the U.S. Federal Reserve.
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