'A tale of two economies': Interest rate policy in Canada and U.S. set to diverge

With monetary policy at the Bank of Canada and U.S. Federal Reserve on track to diverge, experts say it could set the Canadian dollar up for volatility down the road.

With monetary policy at the Bank of Canada and U.S. Federal Reserve on track to diverge, experts say it could set the Canadian dollar up for volatility down the road.

If the Bank of Canada's rate falls too far below the Fed's, it could negatively affect the loonie, said Allan Small, senior investment adviser at IA Private Wealth. This would make imports from the U.S.-- Canada's biggest trading partner -- more expensive and put upward pressure on inflation, though he added this isn't something that happens overnight.

"If the Bank of Canada cuts a few times and the Fed stands pat, I don't think that will be an issue," he said.

But if the Bank of Canada keeps cutting and the Fed holds on past the first quarter of next year, "then we could start to see significant divergence."

The Fed is widely expected to hold its key interest rate steady on Wednesday as the country's economy has been more resilient than expected in the face of higher borrowing costs and inflation.

It's a different story in Canada, where last week, the Bank of Canada announced its first interest rate cut in more than four years after a steep hiking cycle aimed at tamping down inflation.

At a June 5 press conference discussing the rate cut, governor Tiff Macklem said the central bank has more confidence that inflation is heading toward its two per cent target.