Bank of Canada Opens Path for Other Central Banks to Diverge from US Federal Reserve Policies

The Bank of Canada, led by Governor Tiff Macklem, has taken a bold step in lowering interest rates and signalled confidence that it can diverge from the United States Federal Reserve (Fed) without facing significant currency pressure. This move is expected to give other central banks comfort that they too can lower their borrowing costs, even if the Fed doesn’t follow suit.

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Macklem’s Dovish Tone Sends Signal of Confidence

The Bank of Canada’s 25-basis point cut to its benchmark overnight rate on Wednesday brought it down to 4.75%, a move widely expected by markets and economists. However, for a central banker with a reputation for caution after some early stumbles, Macklem’s surprisingly dovish tone showed growing confidence that the worst of the inflation fight is behind him.

In an interview with reporters, Macklem said it was reasonable to expect more cuts if price pressures continue to cool. He also pushed back on questions about the Bank of Canada veering from the Fed, saying there’s no bright line and historical precedent shows periods of considerable divergence.

Canada’s Policy Rate Now 75 Basis Points Below Upper Bound

Macklem emphasized that Canada’s policy rate is now 75 basis points below the upper bound of the Fed funds rate. He stated that he doesn’t think they’re close to that limit, adding, "There’s no sort of bright line, and you can see from history there have been periods of considerable divergence."

This statement has significant implications for other central banks. If most of the inflation being seen in the U.S. is primarily driven by services and the strength of the domestic economy, other nations can focus on setting monetary policy for their own situations. And Canada’s domestic economy is clearly weaker than that of the U.S.

Central Banks Face Similar Inflation Pressures

Carolyn Rogers, the Bank of Canada’s second-in-command, noted that central banks faced similar inflation pressures starting in 2021 due to a run-up in commodity prices and supply-chain problems. She said, "Although we were quite coordinated on the way up — and that was really helpful because a big part of inflation was global — you’re going to see some divergence on the way down and that makes sense."

Economists Weigh In

Some economists were struck by Macklem’s confidence at a historic moment. After a rocky start to the hiking cycle, he appears close to victory over inflation without triggering a deep recession.

However, analysts like Bank of Nova Scotia’s Derek Holt warned of the risks of overconfidence. He stated that saying Canada is "not close" to the limits of Fed divergence is "way more aggressive" than Macklem needed to be.

TD and Scotiabank Forecast More Cuts

The governor’s tone and forward guidance prompted Scotiabank and other big banks to forecast more cuts than previously expected in Canada this year. Still, when reporters pressed Macklem about whether a July cut would be next, he turned the discussion back to Wednesday’s announcement.

With assistance from Randy Thanthong-Knight and Jay Zhao-Murray.