Canadian Interest Rates

Canadian Interest Rates - Last 60 Years

The Bank of Canada is the central bank responsible for monetary policy in order to ensure that a stable economy is maintained, inflation is kept under control, and that the usd to cad rate is maintained at levels which benefit the Canadian economy and its trading partners. One of the key responsibilities of the bank is for setting and maintaining  interest rates throughout the year, so let’s start by looking at this aspect and how it is likely to affect current and future currency exchange rates between the Canadian and US dollar.

The principle mechanism by which the Bank of Canada attempt to provide economic stability, growth, and control of inflation is of course interest rates. The  chart to the left ( courtesy of the Bank of Canada ) shows how the bank has changed rates since 1940 to date, reaching a peak in the early 1980’s of 21%, to today’s current levels of 4.00%. Prior to November 2000, interest rate announcements were made on an ad hoc basis according to the prevailing economic conditions, but from November 2000 onwards, and in line with many other industrialized nations, the Bank of Canada introduced a fixed approach to announcing rate changes, and policy statements on the economic outlook for the future. The bank now announces its decision at eight fixed dates during the year starting in late January and thereafter in early March, mid-April, late May, mid July, early September, mid-October and finally in early December. The Bank retains the option of taking action between fixed dates, but only under extraordinary circumstances. The U.S. Federal Reserve also sets rates eight times a year. The Bank of Canada is responsible for setting the target for the overnight rate. This is the rate at which banks lend to one another to cover their daily positions. The target for the overnight band is 0.5% so if the rate were 3.25% to 3.75%, then the rate they would lend at is 3.75% and the rate for deposits would be 3.25%. When the central bank adjust the overnight rate they are sending a signal to the banks that they want them to adjust their prime rates. The banks usually follow suit!

The single most important goal of the Bank of Canada is to control inflation, by using the rather blunt instrument of interest rates. The Government of Canada have agreed on an explicit target for inflation control, which is currently within a range from 1 to 3 per cent. The instrument that the Bank uses to ensure that inflation remains within this target range is the Bank Rate—the rate of interest that the Bank charges on short-term loans to financial institutions. Now the problem of course is that any action that the bank takes now, will take at least 18 to 24 months to filter its way through into into the broader economy, so any increase in rates is generally considered a sign that inflationary pressures are starting to take hold, which may in turn affect the usd to cad rate.

Six years after it hit an all time low in 2002 the Canadian dollar has gained almost 40% against the US dollar and the question everyone is asking is whether this trend will continue, and if so for how much longer. On the economic front, the data presented by the Bank of Canada has continued to indicate a slowdown in growth particularly in the manufacturing sector. Canadian job prospects remain good, which would suggest that the economy is resilient at present to any slowdown. However, with the possibility of a full recession in the US, then further slowing of the Canadian economy is inevitable. In recent months the combination of favourable inflation figures and evidence of weaker growth will, I believe, encourage the Bank of Canada to cut interest rates to follow those in the US, but that these cuts will be small to avoid the possibility of increasing inflationary pressures in the economy.

We will look at the trade surplus shortly in more detail, but in recent months this has moved lower as Canada’s vital export markets have weakened. In addition commodity prices are also likely to weaken although the overall fundamentals remain strong. Overall, I believe that the Canadian dollar is unlikely to weaken sharply against the US dollar, but the current position of parity may be difficult to sustain in the longer term and a move back to around 1.10 or 1.15 would seem the most likely target. If resistance is penetrated at 1.15 then the Loonie could weaken further. Having looked at  interest rates and the central bank’s role in maintaining a stable economic environment, both for trade and also for the usd to cad currency, let’s look at one of the most important commodities for the future economic prosperity of Canadians, oil, and how this could affect the future currency exchange rates.