The Bank of Canada cut its key interest rate by a quarter of a percentage point on Wednesday, widening the growing gap between interest rate policies in Canada and the U.S.
Experts say the gap between the two central banks is here to stay.
Mackenzie Investments senior economist Jules Boudreau says there will be a meaningful difference between rates in Canada and the U.S. for the next decade due to the two countries’ differing economies.
The Bank of Canada’s overnight rate is now three percent, after an aggressive succession of cuts last year beginning in June brought it down from a high of five percent.
Later on Wednesday, the Bank of Canada’s U.S. counterpart is widely expected to hold its own key rate steady, as the economy south of the border has remained more resilient in the face of higher rates.
The U.S. Federal Reserve cut its rate three times last year, bringing its key rate to a range of between 4.25 percent and 4.5 percent more than a full percentage point higher than its Canadian counterpart.
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The gap is among the factors weighing on the Canadian dollar, which has been trading below 70 cents US for more than a month.
But despite the gap’s effect on the loonie, Boudreau said he thinks the Bank of Canada likely isn’t too concerned for now, noting that if the U.S. does levy tariffs on Canadian goods that could insulate manufacturers in Canada from some of the effects.
“If you ask me, over the next decade, we’re going to see a one to two percent spread in the Bank of Canada rate versus the Federal Reserve rate. We haven’t seen that over the past few decades, but that’s because the economies were very similar between Canada and the U.S.”
According to a TD economics report from May 2024, the last time a significant gap between the two country’s interest rates persisted was between 2003 and 2006, when the Fed hiked rates to slow U.S. economic growth amid rising real estate prices.
Historically, a one-percentage-point spread has been sustainable, according to the report, noting that in early 1997 the gap between the two rates was 2.5 percentage points.
In addition to the effect higher interest rates have had on the economy, Canada faces slowing population growth and a likely decrease in government deficits if the Conservatives take power, while the Trump administration is set to spend big, said Boudreau.
“Even before the tariffs, you would have needed to see a gap between the two rates,” he said, due to the marked difference in economic strength between the two countries.
“It’s pretty clear that we’re going to see that spread getting maintained, and we should, because you want to set interest rates in relation to your domestic economy,” he said.
With possible tariffs from the U.S. on the horizon, the Bank of Canada is in a tough spot, said Edward Jones senior investment strategist Angelo Kourkafas, because of the threat to economic growth.
If the loonie weakens further, it would be inflationary, but “I don’t think we are at extreme levels,” he said.
“I think there’s no real concerns for now that the divergence is really either creating another wave of inflation or really has impacted financial markets,” he said.
