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What does another US Federal Reserve rate hold mean for Canadians?

As of this week, the Bank of Canada (BoC) and its American counterpart, the US Federal Reserve, are on two different paths when it comes to interest rate policy.

The Fed opted to hold its federal funds target rate – which is used to influence the cost of US variable-rate borrowing, including mortgages – in a range of 5.25% - 5.5% on Wednesday, as inflation remains too high for the central bank’s comfort. According to the “dot plot” – a forward looking analysis that is released along with the rate decision – the Fed is on track for just one quarter-point cut later this year, compared to the previously expected three.

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated. In recent months, there has been modest further progress toward the Committee’s 2% inflation objective,” states the Fed’s rate announcement.

“In support of its goals, the Committee decided to maintain the target range for the federal funds rate at 5.25 to 5.5%. In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.”

Stubborn inflation continues to challenge the Fed

The Fed’s announcement followed a US inflation report that showed the Consumer Price Index (CPI) had grown 3.3% annually in May; slower than the expected 3.4%, but still well above the Fed’s target. On a positive note, the “supercore” CPI measure that the Fed likes to track declined slightly from April to May. But, as RBC economist Claire Fan writes, one month doesn’t make a trend.

“Progress on inflation has improved slightly over April and May but not nearly enough to fully reverse the upward trend seen earlier in Q1,” she writes in an economic note. “Amid those uncertainties, [the] US Fed again reiterated that interest rates will need to stay higher until greater confidence that inflation will return to the 2% target can be built.”

The impact on Canadian borrowers

While the Fed’s rate decision won’t directly impact Canadians, there are plenty of implications for our economy, which will trickle into the Canadian cost of borrowing. Most notable is the fact that the BoC and Fed are diverging on their rate direction. The BoC is now entering a rate cutting cycle,  lowering its Overnight Lending Rate – which controls the cost of borrowing in Canada – last week by a quarter of a percentage to 4.75%. Market analysts are expecting at least two more cuts in 2024, and for the benchmark rate to possibly lower by a full percentage point by next year. Lowering this key rate in turn decreases Canada’s prime rate, which controls the cost of variable mortgage rates, as well as savings products such as Guaranteed Income Certificates (GICs) and high-interest savings accounts.

The BoC's rate cut has been supported by improving inflation in Canada, which came to 2.7% in April. This shows the previous rate hikes put in place by the central bank to cool the CPI have done their job, and can start to be unwound.

Historically, though, the two central banks typically move in tandem to prevent currency shocks and keep trade flowing between the two countries. If the BoC continues to cut rates much further than the Fed’s path, that could weaken the Loonie and potentially drive Canadian inflation higher.

A recent analysis from Desjardins economists suggests a 10% decrease in the Loonie’s spending power would have the same economic impact as a 1% rate decrease (four cut’s worth). While the BoC will need to factor this impact into their decision making, they write, the central bank still has some wiggle room before currency issues become a concern.

“To account for this, we now see four Bank of Canada rate cuts this year instead of five and a somewhat slower pace to easing in 2025 as well,” they write. “Make no mistake, we still expect the policy rate to fall materially from current levels as Canadian central bankers combat the effects of mortgage renewals and more muted population growth. Our new forecast simply assumes a slower pace of adjustment given the divergence in monetary policy that is likely to occur as the Fed remains on the sidelines for longer.”

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Penelope Graham, Director of Content

Penelope has over a decade of experience covering real estate, mortgage, and personal finance topics and her commentary on the housing market is featured on both national and local media outlets.