04:35 PM EDT, 05/16/2024 (MT Newswires) -- Desjardins economists Royce Mendes and Tiago Figueiredo late Thursday afternoon published a detailed note entitled 'Strategic View: Testing the Limits of Monetary Policy Divergence'.

Of interest at the end of this note, the Desjardins duo note that with markets only expecting two Bank of Canada rate cuts this year, there's little divergence priced in between the BoC and the Federal Reserve. As a result, they said, there's scope for the loonie to weaken if, as they expect, Canadian central bankers pivot to a more dovish stance in the months ahead. To calibrate the cadence of rate cuts, they added, Canadian policymakers will need to incorporate that exchange-rate weakness into their outlook. "The Bank of Canada should view currency depreciation as a substitute for some rate relief," according to the Desjardins pair.

To account for this, they now see four instead of five BoC rate cuts this year and a "somewhat" slower pace to easing in 2025 as well. "Make no mistake," they said, "we still expect the policy rate to fall materially from current levels as Canadian central bankers combat the effects of mortgage renewals and more muted population growth. Our new forecast simply assumes a slower pace of adjustment, given the divergence in monetary policy that is likely to occur as the Fed remains on the sidelines for longer."

The Desjardins duo said unless central bankers become worried about inflation expectations, it will be more important to monitor the currency's impact on the real economy than on near-term dynamics in consumer prices. They noted the BoC's core median and trimmed mean measures do a much better job of filtering out temporary fluctuations tied to exchange rate pass-through than CPIX or CPI ex-food and energy. "Of course," the duo concluded, "we continue to believe our bias-adjusted measures of inflation are superior to all of these in terms of filtering out transitory disturbances while still tracking changes in the output gap."