The Bank of Canada will be watching for ripple effects if the U.S. Fed raises rates this month.

And, it may not follow suit: economists expect the Fed’s policy to diverge from that of other central banks.

It was a point not lost in the Bank of Canada’s release on Wednesday when it held its benchmark interest rate at 0.5%, calling such a split “a prominent theme.”

The expected policy gap has already led investors to sell the euro against the U.S. dollar and purchase European stocks. In Canada, higher U.S. interest rates would cause the loonie to weaken relative to the U.S. dollar and may ruffle the housing market.

“A rise in U.S. rates will filter through into the Canadian domestic economy, and we might see a little bit of an uptick in mortgage rates,” says Prab Sagoo, a Canadian equity market analyst for Nasdaq Advisory Services in Montreal. “We may see some de-levering on the domestic housing market.”

Read: What Brad Pitt thinks of the U.S. housing market

The BoC acknowledged housing market risks, noting in its release: “Vulnerabilities in the household sector continue to edge higher.” Canada’s ratio of household debt to disposable income was at 164.6% in Q2 2015, up from 163% in Q1, according to Statistics Canada data.

A Canadian rate cut would pinch banking stocks, while a rate hike would cause utility stocks to suffer, Sagoo says. Keeping rates low benefits consumer stocks.

Read: More central banks surprising investors, says report

U.S. rate rise, currency and bonds

The U.S. Commerce Department said last week that GDP grew more than expected in the third quarter, at an annualized rate of 2.1%, strengthening the argument for the Fed to hike its benchmark rate at its December 16 meeting.

Yet, more central bank stimulus is expected in China, Japan, and Europe. The European Central Bank will likely extend its QE program tomorrow, a move that would further weaken the euro. The yen has also fallen as the Bank of Japan buys government bonds.

Darcy Briggs, a portfolio manager at Franklin Bissett Investment Management in Toronto, says he expects the BoC to remain on the sidelines as Fed policy evolves.

“They really don’t have a lot of firepower left,” Briggs says of the Bank of Canada, which cut its benchmark rate twice this year in response to the crash in oil prices. It previously cut its rate below the 0.5% mark, to 0.25%, amid the 2009 crisis.

Briggs adds that the prospect of a Fed rate hike is already being priced into Canadian and U.S. bonds. “It’s not going to come as a surprise. You could see [sovereign] rates drift higher in the U.S. and Canada in the five-year space,” he says.

Read: Central banks running out of options

Canadian growth

The BoC expects economic growth to moderate in Q4 2015, though it did not change its forecast for 1.5% annualized GDP growth for the quarter. The bank forecasts growth of 2% in 2016 and expects the economy to reach full capacity in mid-2017.

“The bank hinted that it’s not going to follow the Fed’s path ahead. […] Risks still lie in rising household debt, but underlying inflation still supports the need for low rates,” wrote CIBC economist Avery Shenfeld in a note to clients.

And, says Sagoo, further monetary easing may be necessary if Canada’s economy continues to be weak.

“If everything stays as-is, commodity prices remain low, and the housing market starts to top off a little bit, the Bank of Canada is more likely to engage in a little more easing rather than hike anytime soon,” he says.

Read: Don’t let a good oil crisis go to waste

The Canadian economy emerged from a mild recession in the first half of the year with 2.3% annualized growth in Q3, Statistics Canada reported this week. But September monthly economic growth was negative, at 0.5%, on disruptions and temporary maintenance shutdowns in the oil and gas sector.

The next BoC rate target announcement is January 20, 2016.

Originally published on Advisor.ca

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