By Ketki Saxena
Investing.com – Yesterday, the Bank of Canada became the first major central bank to pause its monetary policy tightening cycle, holding rates at 4.5%. The move had been largely expected after the Canadian central bank clearly signaled a conditional pause in January.
While the decision brought relief to Canadian markets and consumers - pressured by the rising cost of interest - and everything else, as inflation soars - concerns have been growing about the divergence of Fed and BoC policy and its negative impacts on the loonie.
A lower expected peak for Canadian rates has pressured the Canadian dollar against its U.S. counterpart, with the loonie a four-month low yesterday following the BoC’s announcement.
The challenge is that a depreciating Canadian currency driving up the cost of imported goods for Canadians, and further add to the inflationary pressures the Bank of Canada is trying to quell.
"If the spread diverges any further there is going to be further depreciation of the Canadian dollar and that will feed in to eventually inflation in this country," said Royce Mendes, head of macro strategy at Desjardins.
Analysts at National Bank of Canada (TSX:NA) concur, but add a positive note to their outlook for the Canadian currency.
“While job creation remains strong, a lacklustre GDP report and slower than expected inflation point to a divergence in monetary policy between Canada and the US. While our new spread forecast is not good news for the Canadian dollar in the near term, we still believe that the reopening of the Chinese economy, coupled with the disruption of commodity supplies due to the war in Ukraine, will help limit the depreciation of the CAD.”
Some analysts however believe that the Loonie’s devaluation could force the Bank of Canada to move more aggressively than it would otherwise like to.
Douglas Porter, Chief Economist and Managing Director Economics at BMO (TSX:BMO) notes, “The BoC can deviate a bit from the Fed, but the currency will act as a limiter on the extent of that deviation. That is, the Bank may not have the luxury of staying on the sidelines if the Fed is still busily marching rates down the field, driving the loonie lower (and thereby sending imported costs flaring higher).”