Opinion: U.S. Federal Reserve taking path laid out by Bank of Canada in rate decision

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On the twisting road to get inflation back to the desired destination of 2 per cent, the U.S. Federal Reserve has decided to try something a little different: putting its foot on the brake and the gas at the same time.

On Wednesday, the central bank decided to hold its federal funds rate steady in a range of 5 per cent to 5.25 per cent. That ended a streak of 10 consecutive meetings, dating back to March, 2022, in which it raised its policy rate.

It would mark a momentous shift in Fed policy direction – except it isn’t.

In the same breath, the Fed made it crystal clear that it’s not done raising rates at all. In fact, the members of the Federal Open Market Committee – the group that sets interest rates – indicated that they expect to increase rates by another half-percentage point before the end of this year. (That’s also a half-percentage point higher than those FOMC members projected in March, when they were last polled on where they thought the policy rate would top out this year.)

So the Fed is merely taking a time out to catch its breath before finishing the job that it has been on steadily for 15 months. Readers, meet The Skip – the Fed’s twist on the new wrinkle that the Bank of Canada introduced earlier this year, The Pause.

In the grander scheme, we’re seeing the Fed declare, in advance, that it expects to follow a path already laid out by its Canadian counterpart. The Bank of Canada signalled at the beginning of the year that it would put its rate hikes on hold while it watched to see how its large increases of the previous year were worming into the economy, and to decide whether rates looked sufficiently restrictive to suppress inflation down to the 2-per-cent target.

After following through on The Pause in March, the Bank of Canada called it off last week – raising its policy rate by another quarter-point to 4.75 per cent.

The Fed is not only mimicking that process, it’s using a lot of the same words the Bank of Canada used in doing so. In its rate decision statement, the Fed talks about taking time to assess additional information in order to determine how much further tightening might be “appropriate.” If it’s not stealing from the Bank of Canada’s book, it’s certainly a substantial homage.

But where The Skip differs is that the Fed is saying – out loud – that it fully expects to find out the same thing the Bank of Canada did: that rates still aren’t quite high enough to snuff out the last embers of the inflation problem.

Even as the Fed takes its break, it’s looking at a lot of the same things that prompted the Bank of Canada to get back on the rate-hike treadmill. The labour market is loosening a bit but is still way too tight. The economy is growing faster than expected. The sliding housing has found its footing. And, critically, core inflation measures – which are designed to get at the broader inflationary pressures across the economy – have remained stubbornly high, even at total inflation has retreated.

The U.S. consumer price index report this week showed that inflation rate fell to 4 per cent, its lowest in more than two years, but the core measure was a much more worrisome 5.3 per cent. The core measure for personal consumption expenditure (PCE) inflation – the Fed’s go-to gauge – was 4.7 per cent in April, and has been stuck in a rut since November. FOMC members substantially increased their end-of-year projections for core PCE on Wednesday.

As Fed Chair Jerome Powell told a postannouncement news conference, lots of indicators are trending in the right direction, but not fast or far enough to make a convincing case for ending rate increases. Nevertheless, he said the Fed wants to take things a little slower as it looks for the finish line for this rate cycle. That might mean that the central bank will skip an occasional meeting as it goes; maybe every other meeting will be a rate increase for a while, giving it more time in between hikes to gather data.

Had the Fed shifted into a genuine holding pattern with Wednesday’s decision, it might have provided the Bank of Canada with a window to do a bit of catching up.

It’s a popular misconception that Canada’s central bank feels compelled to move its rates in line with its U.S. counterpart; it simply isn’t the way the bank operates. Still, a rising Canadian rate policy at the same time as a steady Fed policy would likely deliver upward pressure to the Canadian dollar, lowering the cost of imports while weighing on demand for Canadian exports. That would take a bit of heat off Canadian inflation at an opportune time.

With the Fed clearly signalling that more hikes are coming, the Bank of Canada can’t look in that direction for help. It won’t change the Bank of Canada’s thinking about taking another pause – or a skip of its own. But it might make that option a little less likely, come the next rate decision in July.