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Interest rates vs. inflation


Rising inflation here in Canada and in the United States is heightening speculation central banks will be looking at interest rate hikes sooner than forecast.


The last report from Statistics Canada put inflation at an annualized rate of 3.6% in May, well above the Bank of Canada’s 2% target. In the U.S. core inflation surged by 4.5%, year-over-year in June – the biggest jump since September of 1991. However, both the BoC and the Federal Reserve forecast the increases are “transitory” and the result of the economy getting itself back on track as we push back the pandemic.


The Bank of Canada bases its statement on, what it calls, the “normalization” of prices that plunged at the start of the pandemic (such as the price of gasoline) and temporary constraints on production and transportation that have prevented supply from keeping up with demand. None the less many market watchers are predicting the Bank will have to raise rates to cool inflation.


In its last report, though, the Bank stuck to its forecast that there will be no increase until the second half of 2022. A key element in that forecast is the central bank’s expectation that Canada’s recovery will benefit more and more as the U.S. recovers and exports to the States grow. But an increase in interest rates would likely drive up the value of the Canadian dollar. In turn, that would make those exports less attractive unless there are corresponding rate hikes by the Federal Reserve. The Fed has said it does not foresee any increases until 2023 or even the first quarter of 2024.


For now both central banks seem content to let inflation run hot, while the rest of the economy rights itself.



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