Exchange Rates and Diverging Interest Rates

Interest rates in Canada and the US have followed separate paths for several months now. In fact, if the Bank of Canada cuts its policy rate faster than the Federal Reserve over the next year and a half, some interest rate spreads are expected to widen even more, especially spreads on shorter term rates. This will keep the Canadian dollar under pressure. Lower interest rates make investments denominated in Canadian dollars less attractive than those denominated in US dollars. But exchange rates are influenced by a whole range of other factors, and the loonie could ultimately prove more resilient than some people may think. For example, back in 1996 and 1997, interest rates in Canada fell far below US rates, but the loonie wasn’t really affected.