The Canada-US interest rate gap is expected to remain following the latest cut, experts predict

The Bank of Canada has reduced 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 predict that the difference between the two central banks will persist.

Jules Boudreau, a senior economist at Mackenzie Investments, believes that due to the differing economies of the two countries, there will be a significant variance in rates between Canada and the U.S. for the next decade.

Following a series of aggressive cuts starting in June last year, the Bank of Canada’s overnight rate now stands at three percent, down from a peak of five percent.

Meanwhile, it is expected that the U.S. Federal Reserve will maintain its own key rate steady, as the American economy has shown more resilience towards higher rates.

Last year, the U.S. Federal Reserve reduced its rate three times, establishing a range between 4.25 percent and 4.5 percent, over a full percentage point higher than its Canadian counterpart.

The widening gap is affecting the Canadian dollar, trading below 70 cents US for over a month.

Despite the impact on the loonie, Boudreau suggests that the Bank of Canada may not be overly concerned at the moment. He notes that potential tariffs on Canadian goods by the U.S. could shield manufacturers in Canada from some repercussions.

Looking ahead, Boudreau foresees a one to two percent disparity in the Bank of Canada rate compared to the Federal Reserve rate over the next decade due to the distinct economic conditions of each country.

According to a TD economics report from May 2024, a significant rate gap between the two countries persisted from 2003 to 2006 when the Fed raised rates to curb U.S. economic growth amidst escalating real estate prices.

Historically, a one-percentage-point difference has been sustainable, as seen in the late 1990s when the gap reached 2.5 percentage points.

In addition to the impact of higher interest rates on the economy, Canada faces challenges like slowing population growth and potential decreases in government deficits if the Conservatives take office. On the other hand, the Trump administration plans for significant spending, further accentuating the economic gap between the two nations.

Considering the potential tariffs from the U.S., the Bank of Canada faces a precarious situation, as noted by Edward Jones senior investment strategist Angelo Kourkafas, given the threat to economic expansion.

Kourkafas highlights that if the loonie further depreciates, it could lead to inflation, but he believes current levels are not extreme. He adds that there are no immediate concerns about the divergence significantly impacting financial markets or causing a new wave of inflation.