Why the Bank of Canada and the U.S. Fed are parting ways

Janet Yellen says she will raise the U.S. benchmark interest rate at last, while the Bank of Canada stays low for longer

(Andrew Harrer/Bloomberg/Getty Images)

(Andrew Harrer/Bloomberg/Getty Images)

This story by Kevin Carmichael was first published by Canadian Business.

The Bank of Canada and the U.S. Federal Reserve are about to part ways, a rare separation that will ensure downward pressure on Canada’s currency. Some will cheer that prospect, as Canadian goods and services will have a price advantage in the U.S. market. The tradeoff is that domestic companies will find it more costly to import state-of-the-art equipment to retool, and to invest in growing markets abroad. Exports could thrive, but productivity may suffer.

All of this crystallized amid a cascade of economic data, monetary policy announcement and speeches over the past few days. Fed chair Janet Yellen on December 2 stated as clearly as central bank lexicon will allow that she will recommend raising America’s benchmark interest rate when she convenes the policy-setting Federal Open Market Committee later this month. It would be the first increase in nine years. The day the Fed raises its target lending rate from zero, “is a day that I expect we all are looking forward to,” Yellen told economists in Washington. Key in her remarks was an emphasis on the importance of staying ahead of inflation. The Fed wants to raise borrowing costs, but very slowly, which means it must get started so it can leave a decent interval before the next increase. “Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals,” of price stability and full employment, Yellen said.

The Bank of Canada is in an entirely different position. It will be staying in the low-for-longer club—likely into 2017, based on current economic forecasts. Before Yellen addressed the Economic Club of Washington, her counterparts in Ottawa released their latest policy statement, in which Canada’s central bank said it was keeping its benchmark interest rate at 0.5%, a quarter-point shy of the lowest level ever. The Canadians described an economy that “continues to undergo a complex and lengthy adjustment” to the collapse of commodity prices.

The good news was the central bank thinks the worst is over. Statistics Canada reported December 1 that gross domestic product expanded at an annual rate of 2.3% in the third quarter after contracting at rates of 0.3% and 0.7%, respectively, in the previous two quarters. Non-energy exports led the rebound, a show of strength that Bank of Canada Governor Stephen Poloz has been waiting on since he started his job more than two years ago. The bad news was that Canada’s other economic engines are sputtering. The value of total household consumption through the first nine months of 2015 is little changed compared with the same period in 2014, according to StatsCan data. And business investment is contracting as commodity companies retreat. The flight of capital might stop, but there is little reason to expect much of it to come back. “We do not see an imminent turning point in commodity prices and thus forecast further negative repercussions on the Canadian economy next year,” Sebastien Lavoie, assistant chief economist at Laurentian Bank Securities in Montreal, said in an analysis of the Bank of Canada’s latest policy statement.

Poloz eschews explicit guidance on where interest rates are headed, but he and his deputies on the Governing Council write their statements in a way that makes deduction possible. In this week’s communication, policy makers highlighted an unusually complicated global landscape. Before the financial crisis, most every economy was doing well, albeit on a bubble of debt and inflated asset prices. After the Great Recession, emerging markets were relatively quick to recover, led by China. Now, the global economy is a patchwork of regions that are doing okay, not so well, and terribly. Each situation will demand different policies, heralding a divergence in interest rates that junior traders on Bay Street never will have seen.

The European Central Bank on December 3 dropped one of its main policy rates to negative 0.3% from negative 0.2% and said it would extend its bond-buying program, under which it creates euros to purchase debt, to at least March 2017. All things being equal, the euro will weaken against the U.S. dollar and perhaps other currencies. (The euro actually rose after the ECB announcement, and stock markets fell, as investors expressed their disappointment with fresh stimulus measures they had bet would be more aggressive.) That is what ECB President Mario Draghi hopes, as he flagged trade as the European economy’s main headwind.

Canada is in a slightly better position than the European Union because it is so closely tied to the U.S., which is growing. Still, the Bank of Canada isn’t taking any chances—it favours a weaker currency. “Policy divergence is expected to remain a prominent theme,” Canadian policy makers said in their December 2 statement, new language that read as a reminder to currency traders that the Bank of Canada sets policy independent of the Fed. And Canada is one of those regions that isn’t doing so well. The Canadian policy statement also reiterated that the central bank expects economic growth has slowed in the fourth quarter, and that the economy won’t regain altitude until sometime in 2016. Yellen is on her own.


Why the Bank of Canada and the U.S. Fed are parting ways

  1. There is no parting of ways here. Same philosophical imperatives underpin both actions. US is witnessing stronger economic growth and wants shore up the currency by increasing the lending rate. Canada wants to shore up a weaker economy by reducing the lending rate. Logical conclusions in both actions are identical. The headline writer is struggling to figure out what’s going on where and why!

  2. Very Very Simple. America’s economy is a real free economy unlike Canada’s which can only be compared with Third World economy relying on Monopolies and Literally Stealing is Legal.
    Just compare cost of living in canada, food, i.e. milk, cars, phone, internet, insurance to name a few, No reliable cost effective transportation going anywhere with your car, though very expensive is still much cheaper than “public” transportation.

    People gradually stop buying things except the “15%” and will get worse majority of canadians “85%” just want to be americans. Canada is going to seize to exist as we know it.

    • I do not know about a free economy. What I see are the rich getting richer and the poor getting desperate. Tell me how that is affordable in the long term?

      Adding trillions of dollar to the debt of the country may spark your economy but personally I think the price is too high. There should be a long term price to pay for all that debt, but the question that needs to be asked is who is going to collect?

  3. This article and the actions of the BOC are hilarious on many levels. The most egregious cause for laughter is that NO Investors care what the BOC rate is, the Canadian Banks will have NO choice but to raise rates as the Fed increases the Canadian Investors MONEY will FLOCK to the U.S. Banks, and the resulting Currency STAMPEDE will Force the BOC to raise rates to help STEM the FLOW of money OUT of Canada’s Financial System.
    P.S. I am going to say “I told you so” when it happens. A.k.a. 1981 World Oil Price Collapse. I was there.

  4. The US and Canada are very different in many aspects except on the issue of interest rates. Canada must more so that the US attract investment but doesn’t not for some reason compete with our neighbour. This is strange given the fact that our two economies are designed to meet two distinctly different criteria. Canadas economy is greared to provide a social safety net where as the American economy thrives on free enterprise with minimum allowances for social security. Given those two definning differneces it is stupid for Canada to play a compliance role with interest rates when considering the the US rate management. Canada should have higher interest rates than the US simply to attract new money to the Canadian markets. Without new money or demanding our corporation invest the concessions taxppayers and consumers are making to finally invest their subsidies in plant expansion, better efficiencies and more employment the effort is wasted. As it stands now every credit given them over the past 15 years is still in corporate pockets while the economy flonders.

  5. Doomed. And most Canadians don’t realise it. Housing (through the FIRE sectors and construction) is a massive proportion of GDP. How can a country build its economy on selling oil to foreigners and cardboard sky boxes to each other, and thinks it’s sustainable?

    Canadians are living on borrowed time. We’re among the most indebted people on the planet. And yet most think history can’t repeat itself and that our resource dependent economy won’t go into a deep freeze or that the housing market won’t crash.

    Anybody who has a speck of intelligence has moved all their assets (but their house) to US$ denominations.

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