The U.S. Federal Reserve is poised to deliver an interest rate cut this week to safeguard a strong U.S. economy against rising trade-war risks – a move that will heighten questions about whether Canada’s central bank will follow suit to address its own trade worries.
The Fed is expected to emerge from its policy-setting meeting on Wednesday with its first rate cut since the financial crisis of 2008, after sending strong signals to financial markets in recent weeks that a cut is imminent. The U.S. central bank will most likely trim its target on the federal funds rate by one-quarter of a percentage point, to a range of 2 per cent to 2.25 per cent, although some observers think the Fed could opt for an even deeper half-percentage-point cut.
The cut will be a reversal for the Fed, which raised rates four times last year in response to strong economic growth and record-low unemployment, and until a few months ago had been expected to continue hiking. It will come at a time when the U.S. economy continues to look healthy, with solid growth, essentially full employment and rising inflation – typically closer to the recipe for rate increases than for cuts.
“I’m not totally convinced that they should be easing at this point in the cycle,” Bank of Nova Scotia economist Derek Holt said.
But the Fed’s turn has less to do with the current state of the U.S. economy than it does with the growing unease surrounding the escalating trade war between the United States and China, the world’s two biggest economies. With evidence mounting that the dispute is already weighing substantially on global trade and investment, and with nervousness that the situation could remain unresolved or even deteriorate, the Fed is leaning toward defensive rate cuts to protect the United States against the risk that the trade war could spark a deeper economic slowdown.
“An ounce of prevention is worth a pound of cure,” Fed chairman Jay Powell said at a news conference after the Fed’s mid-June rate decision. “I think that is a valid way to think about policy in this era.”
Many observers latched on to that phrase as a sign the Fed may be thinking about only one or two quarter-point cuts over the next few months. Yet, the financial markets have priced in the likelihood of as many as four cuts over the next year. Markets will be parsing the Fed’s rate-decision statement, as well as Mr. Powell’s comments in his news conference, to gauge how deep the Fed is prepared to cut.
But the Fed is hardly alone in its concern about the increasing risk posed by trade disputes, and the need to take early action to support the economy against a slowdown. A growing list of central banks – including those of the European Union, Australia, New Zealand, India and Russia – have either cut rates or signalled their intention to do so. With the Fed, the most powerful and influential central bank in the world, poised to join the rate-cutting trend, there will be heightened questions about whether other central banks, including the Bank of Canada, should follow suit.
While the Bank of Canada has given no indication that it is nearing a rate cut, its concern about the trade climate has increased markedly. In its most recent interest-rate decision in mid-July, in which it held rates steady, trade worries dominated its discussion.
Nevertheless, economists point out that the Bank of Canada’s key rate, at 1.75 per cent, is already well below that of the Fed – and below what is considered its neutral range, meaning it is already providing stimulus to the Canadian economy. In addition, the economy has been picking up speed, rather than slowing: Economists estimate that the economy grew at a pace of about 2.5 per cent annualized in the second quarter.
And the Bank of Canada’s core inflation gauges have been signalling that inflation has stabilized around the central bank’s 2-per-cent target, or even slightly above it. Taken together, that all suggests the Bank of Canada has little rationale to match the Fed’s cut.
The Bank of Canada also has time to see how the Fed cut plays out, and how the Canadian and global economies evolve, before it considers its next move. Its next rate decision doesn’t come until Sept. 4.
“They can basically take the summer off and watch,” Mr. Holt said.
He added that the rate-easing trend elsewhere has served to lower global bond yields – which, because of the interrelated nature of the world bond market, has dragged down market interest rates in Canada as well, even without the Bank of Canada moving on its official rates.
“We’re getting easing. We just didn’t cause it,” he said.
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David Parkinson