By Fergal Smith

TORONTO (Reuters) – The Bank of Canada would be willing to cut interest rates three times before the Federal Reserve's first move before a currency decline threatens to jeopardize inflation expectations, the average estimate of seven analysts in an informal poll showed.

The weakness of the Canadian dollar against the dollar this year sparked debate among investors about the extent of the Bank of Canada's willingness to move away from its American counterpart.

Investors expect the Bank of Canada to begin cutting interest rates in June or July, with next Tuesday's inflation reading a key input. But the Fed is expected to hold off until September, even after cooler-than-expected US inflation data was released on Wednesday.

The Bank of Canada's benchmark interest rate, at 5%, is already 38 basis points below the midpoint of the Fed's interest rate range. Further widening of the spread could increase pressure on .

However, analysts say it would take a significant move in the currency to raise import costs enough to jeopardize the central bank's efforts to lower inflation to the 2% target.

The higher cost of imported goods tends to raise the prices that companies charge to consumers.

“Although there is a theoretical limit to how far the Bank of Canada can set its interest rate below the federal funds rate, it is likely to be well below current levels,” said Carl Schamotta, chief market strategist at Corpay.

“The exchange rate may weaken if interest spreads widen further…but the transition to inflation should be relatively modest.”

The latest data shows that inflation reached an annual rate of 2.9% in March, down from a peak of 8.1% recorded in June 2022.

The Canadian dollar has already fallen nearly 3% against its US counterpart since the beginning of the year, to 1.3640 per US dollar, or 73.31 US cents, with the US currency rising against a basket of major currencies.

“As a rule of thumb, a 10% decline in the Canadian dollar would boost commodity prices by 2.5%,” Olivia Cross, North America economist at Capital Economics, said in a note, adding that commodities make up about 30% of GDP. Total. Canadian CPI basket.

Bank of Canada Governor Tiff Macklem said earlier this month that there is a limit to how far apart US and Canadian interest rates can be, but “we are certainly not close to that limit.”

The Canadian economy has lagged behind the U.S. economy in recent quarters, hurt by weak productivity growth as well as higher household debt levels and a shorter mortgage cycle, a factor some economists say should lead the Bank of Canada to move before the Fed.

The Organization for Economic Co-operation and Development expects the Canadian economy to grow by 1% this year, well below the 2.6% rate it expects for the United States.

The interest rate gap has remained around 100 basis points since the global financial crisis of 2008-2009. However, that level may not be a binding hurdle if Canada's outlook deteriorates during the second half of 2024, said Robert Booth, chief macro strategist at TD Securities.

“The greater-than-expected pressure on the household sector from mortgage renewals could give the bank more license to move away from the Fed,” Booth said.