Why Canadian Interest Rates Beat to Their Own Drum

As far as Google search trends go these days, ‘What causes inflation?’ has got to be up there somewhere not too far from ‘Elon Musk children’. While Canada’s inflation scenario shares a lot of similarities to our neighbors down south, it’s important noting that there are some key differences as well.

A recent article on the Financial Post argues that since the Loonie hasn’t risen with oil prices as it normally does, this has complicated the Bank of Canada’s fight against inflation. The result is the central bank’s current policy rate of 2.5%, the highest its been since 2008. In his interview with the Post, Bank of Canada governor Tiff Macklem says: “When the price of oil in U.S. dollars goes up, the Canadian dollar tends to appreciate. What does that do? One, it dampens the inflationary shock for households at the gas pump, because it means the price in Canadian dollars doesn’t go up as much because the Canadian dollar absorbs some of that. The other thing it does is that it spreads the benefits to Canada of a higher oil price because we’re an oil exporter. It spreads it more across the economy.”

The result is that a low dollar is compounding Canada’s inflation problem and some feel that this may force the BOC’s hand more than what’s happening in the US. While global factors like the war in Ukraine and ongoing supply issues are drivers of inflation, “domestic price pressures from excess demand are becoming more prominent” says the Bank of Canada. BOC goes on to say “surveys indicate more consumers and businesses are expecting inflation to be higher for longer, raising the risk that elevated inflation becomes entrenched in price- and wage-setting. If that occurs, the economic cost of restoring price stability will be higher.”