Bank of Canada Governor Tiff Macklem addressed the Canadian legislature’s finance committee on Thursday, discussing the central bank’s ability to cut interest rates while the Federal Reserve maintains elevated levels. Macklem’s testimony came amid concerns that a series of rate cuts by the Bank of Canada, combined with the Fed’s decision to keep rates steady, could lead to a weaker Canadian dollar and subsequently higher inflation.

Macklem acknowledged that Canada’s flexible exchange rate allows for some divergence in monetary policy from the United States, but he also noted that there is a limit to how far interest rates can differ between the two countries. However, he emphasized that Canada is not close to reaching that limit.

“Because we have a flexible exchange rate we can run our own monetary policy, so our interest rates in Canada don’t need to be the same as the US rate,” Macklem said to the finance committee. “There is a limit to how far they can diverge, [but] we’re certainly not close to that limit.”

When questioned about the level of weakness in the Canadian dollar that the central bank is willing to tolerate, Macklem refrained from providing a specific threshold. 

“I’m not going to draw a line in the sand,” he said. “Clearly, if we cut interest rates and that weakens the Canadian dollar, that is something you have to take into account.”

Market participants anticipate the Bank of Canada to begin cutting rates in June, with expectations of four reductions in total, bringing the benchmark interest rate down to 4% from its current 5% level. In contrast, the Fed has maintained its benchmark rate between 5.25% and 5.5%. Macklem indicated that the Bank of Canada is “getting closer” to rate cuts but wants to ensure that the recent slowdown in inflation is sustainable.

The governor also noted that higher interest rates in Canada have caused more strain on consumption compared to the US, due to differences in the mortgage market and higher household debt levels in Canada. While some economists believe that the Bank of Canada can cut rates by a full percentage point below the Fed without causing significant disruption, others suggest that a move below 4.5% will depend on the sensitivity of the Canadian dollar and the evolution of domestic economic conditions.

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