How could aggressive rate increases in the U.S. affect Canada?

As the US inflation showed the highest result in 40 years last month reaching 7.5%, Canadian experts are waiting to see how possible Federal Reserve rate increases may affect fiscal policy here.

The January gain of 0.6% from December seen in the US, exceeded experts’ previous forecasts of a 0.4% hike.

According to a Federal Reserve board member James Bullard, such inflation levels should make the Fed consider a rate increase as soon as possible. In order to offset the economic influence of elevated inflation, Bullard calls for a 1% increase by July 1.

Matthew Luzzetti, chief US economist at Deutsche Bank, says this development will certainly set the Federal Reserve on its course to start raising rates in March.

“The recent CPI data, which was up by more than expected driven by rent and medical services, has transformed that risk scenario into a baseline,” – Luzzetti noted.

“As the inflation pressures show signs of growth in the near term, we now expect the Fed to raise its key lending rate by 0.50% next month.”

Before the announcement of the possible “unexpected” Fed increase, BMO Financial Group CEO Doug Porter said that the Bank of Canada’s decision to postpone rate hikes was caused by pandemic-related challenges.

In his opinion, inflation will probably be the most important factor determining the timing for the BoC’s first rate hike.

“In case the inflation doesn’t show signs of at least some moderation by the middle of spring here, then we might start talking about the possibility of the Federal Reserve and the Bank of Canada raising rates by more than 0.25%,” – Porter noted.

“It would show that they’re extremely concerned about the inflation issue, and that they’ve fallen behind the curve. In fact, I believe they’re already slightly concerned about it.”

Earlier, the central bank’s Governor Tiff Macklem said the Bank’s rate hikes will take into account the readiness of Canadian businesses to get back to full capacity, amid the economy’s steady recovery from the COVID-19 pandemic.

According to Macklem, the BoC has a strong reason to start raising rates soon in order to bring inflation back to the 2% target rate. Otherwise, the inflation will moderate to only 3% by the end of this year.