Inflation in the United States may prompt the Bank of Canada to raise interest rates above 4%

Economists say US price pressures could encourage the Central Bank of Canada to move more aggressively to fight inflation

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If the US economy sneezes, Canada could catch a cold. That’s what economists are warning when they review US CPI readings this week and consider how they might push the Bank of Canada to get tougher in its fight against inflation.

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While US CPI growth slowed in August to an annual pace of 8.3 percent, down from 8.5 percent in July, price pressures remain hotter than economists’ expectations of 8.1 percent. The release sent equities down the most since 2020 and prompted economists on both sides of the border to revise their expectations for rate hikes for the rest of the year, with some predicting interest rates will move north of the four percent mark.

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Derek Holt, head of capital markets economists in the Bank of Nova Scotia’s economics team, wrote in a note dated September 13. Holt added that along with Canadian fiscal stimulus, which Scotiabank said is adding fuel to the flames of cost pressure, economic data out of the US could encourage the Canadian central bank to move more aggressively to combat inflation.

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“The Federal Reserve will likely go hand in hand with domestic fiscal stimulus boosting the probability of a 4 per cent policy rate breach by December if not October,” Holt wrote.

Economists at Toronto Dominion Bank also revised their forecast for a rate hike this week as they moved estimates of the final interest rate – the maximum the central bank is expected to achieve in a rate-raising cycle – from 3.5 per cent to 4 per cent in their base assumption. . In a note Wednesday to clients, Andrew Kelvin, TD Canada’s chief strategist, indicated that a final interest rate of 4.75 percent was also acceptable.

How inflation trends play out at home will undoubtedly influence the Bank of Canada’s next move. the address Inflation figures for July It fell below the 8 percent mark to an annual pace of 7.6 percent, largely due to lower gasoline prices. August CPI data for Canada is expected next week.

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Wage growth is another piece of the puzzle that can cause prices to rise faster. First Deputy Governor Caroline Rogers reporters last week That was one factor the bank would be watching closely as employees demand higher salaries or pursue higher-paying jobs to keep up with the rising cost of living. But it warned that the increase in wages may lead to a spiral of wages and prices and lead to the entrenchment of inflation.

Royce Mendes, managing director and head of overall strategy at Desjardins, noted this dynamic in a September 14 note to clients, using US wage growth data (since the Canadian numbers don’t go far in time) to show how the pay-rise period was quickly cut short in recession aftermath. To avoid a “nightmare scenario” for wages that causes higher inflation to become the norm, Mendes said the bank has no choice but to target a recession.

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“The only sure way to contain this danger is to fly a kamikaze mission,” Mendes wrote. “Looking at the US wage data…it’s clear that recessions can break the cycle.”

Mendes added that the odds of a recession in the US have “significantly increased” and that Fed officials will be less inclined to put the brakes on the current rate-raising cycle anytime soon.

“In a typical environment, Canada might be able to avoid a recession if the United States were to go into only a mild recession,” Mendes said. “However, with central bankers north of the border continuing to aggressively raise interest rates, that is a slim prospect today.”

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Mendes currently expects a final interest rate of 3.75 percent, although he said it is very likely that Desjardins economists will have to boost it based on inflation data and the degree of tightening created by the central bank.

TD Chief Economist Beata Karanchi told Larysa Harapyn in September 8 interview The Bank of Canada could have moved higher than the US Federal Reserve, pointing to a tighter labor market, more resilient consumers, and large stores of savings.

“Canada is definitely on the higher end of what we’re seeing from some of its major peers (with a 3.25 per cent policy rate),” Karanchi said. “I would also say that it is very likely that we will have the Bank of Canada which will have to rise to a higher level than you will see outside the US, and I think a lot of Canadians might be exposed to that because we tend to look at the US as a barometer of what to expect in Canada , but we have a tighter labor market than in the United States.”

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