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Still Room For More BoC Cuts Before Hitting Fed Divergence Limits

BOC
  • Economists and the BoC say the Bank has room for further divergence from the Fed but some investors anticipate that exchange rate depreciation could cause imported inflation.
  • The spread between the BoC and the Fed is 75 bps. Markets anticipate 2-3 more cuts by the BoC this year while the Fed dot plot has one cut vs the three previously expected.
  • Despite the speculation, traders were always free to sell CAD and there hasn't been significant weakness following the June 5 cut.
  • Macklem dismissed divergence concerns "there are limits to how far we can diverge from the US, but we're not close to those limits." The governor pointed to historic divergence as a guideline.
  • The largest negative spread for the BoC since the 2000s was 100 bps, a difference Canadian banks call sustainable.
  • BMO expects one more independent BoC cut before any currency stress emerges; CIBC expects 1-2 more cuts.
  • BoC's DSGE model predicts a -10% CAD shock to cause +25 bps in core CPI over 12M and +90 bps to long run CPI, showing limited pass-through. CIBC predicts that a 100 bps divergence would increase long-run CPI by 10-40 bps.
  • Senior Deputy Governor Carolyn Rogers said "it's logical that we're going to diverge a bit because we're responding to what's in our domestic economy," unlike the coordinated global response to the pandemic.
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