Fed raises rates for the first time since 2023, widening the gap with the Bank of Canada

The U.S. Federal Reserve raised interest rates on Wednesday for the first time since July 2023, a move that widens the gap between U.S. and Canadian borrowing costs and weighed on the Canadian dollar.

In a unanimous 12-0 vote, the Federal Open Market Committee lifted the target range for the federal funds rate by a quarter of a percentage point to 3.75% to 4%, from the 3.5% to 3.75% range it had held since December. The statement said the move "will support a timelier return" to the Fed's 2% inflation goal.

The decision vs expectations

The hike was widely expected. CME FedWatch put the probability above 90% before the announcement, Euronews reported. What mattered more for markets was the outlook:

The Fed's preferred inflation gauge, the PCE index, was running at 3.7% in June and July, with core inflation at 3.3%, up from 3% before the Iran war pushed fuel prices higher. U.S. President Donald Trump criticized the decision, saying rates "should be 1%, or less."

• 12 of 18 officials expect one more quarter-point hike by year-end, and four see rates reaching 4.375%
• 14 officials expect rates at the end of 2027 to be above today's level
• The median projection for 2028 rose to 3.9% from 3.4%

The Canadian angle

The Bank of Canada held its own policy rate at 2.25% on Sept. 2, leaving it well below the Fed's new range. A wider gap tends to make U.S.-dollar assets more attractive and puts downward pressure on the loonie.

That is what happened on Wednesday. The Canadian dollar settled at 71.70 U.S. cents, down from 71.85 cents on Tuesday, and traded near 1.40 per U.S. dollar, its weakest level in more than a month. The S&P/TSX composite index lost 90.80 points to close at 35,491.27, while West Texas Intermediate crude fell 3.5% to US$102.11 a barrel.

Will the Bank of Canada follow?

Not necessarily. Canada's inflation was 3.0% in August, but the Bank's preferred core measures were near 2%. The Bank has said it is prepared to raise rates if inflation stays elevated, while also flagging that new tariffs make the growth outlook more uncertain. The two central banks face different economies: the Fed describes U.S. activity as expanding at a solid pace with robust investment, while Canada is absorbing a trade shock.

The risks

A weaker loonie makes imported goods, travel and U.S.-priced products more expensive for Canadians, which can add to inflation. If the Fed hikes again in December, as most officials projected, the gap could widen further. On the other hand, if energy prices fall, both central banks could have less reason to tighten. Projections are not commitments and can change quickly with oil prices and geopolitics.

What it means for an ordinary Canadian investor or household

Canadian variable mortgage rates follow the Bank of Canada, not the Fed, so Wednesday's move does not directly change your payment. It can, however, influence Canadian bond yields and fixed mortgage rates indirectly.

If you are planning U.S. travel or purchases, a softer loonie raises the cost. Investors holding U.S. stocks or ETFs in Canadian dollars may see currency gains when the loonie falls, and losses when it rises. Holding some U.S.-dollar savings can help if you have regular U.S. expenses. This is general information, not personalized advice.

Related

• U.S. dollar accounts in Canada
• Fixed vs. variable mortgage

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