the bank holds its ground

This morning, the Bank of Canada held its trend-setting policy interest rate at 2.75%, its lowest level since August 2022. This was the second consecutive policy rate announcement in which the Bank elected to maintain the rate after seven consecutive cuts beginning in June of last year.

The Bank’s rationale for keeping its policy rate at its current level stems from its sole mandate: to keep inflation within a 1-3% range and maintain average annual inflation at 2%. Although headline inflation decreased to 1.7% in April, the Bank’s preferred core measures of inflation (which strip out the most volatile components) rose above 3%. In its release the Bank noted that "recent surveys indicate that households continue to expect that tariffs will raise prices and many businesses say they intend to pass on the costs of higher tariffs”.

Unlike the Federal Reserve, the Bank of Canada does not have a dual mandate to maintain inflation and maximum employment. Canada’s job market has been weakening the past few months under the weight of uncertainty from the ever-evolving trade dispute between the United States and the rest of the world (including a doubling of the tariff rate on steel and aluminum imported into the US to 50% today; note that around 90% of Canadian steel and aluminum exports go to the US). Expect continued softening in Canada’s labour market in the months ahead. While tariffs ultimately raise prices, they also dampen demand in the long run. Additionally, short-term fluctuations can also complicate the economic outlook. The Q1 Canadian GDP numbers were more robust than many had expected (+0.5% in Q1 from the previous quarter), however, that total was buoyed by increased exports to the United States, as US businesses stockpiled imports ahead of the tariff implementations. This suggests that a pullback in exports and overall output is likely in Q2.

The Bank has consistently stated its focus on maintaining price stability and that “monetary policy cannot resolve trade uncertainty or offset the impacts of a trade war.” While this is accurate, there is growing evidence that the Canadian economy is weakening, warranting more expansionary monetary policy. In our view, the Bank should lower its policy rate below the current low end of the “theoretical neutral range” (2.25%) sooner rather than later. The next policy rate announcement is on July 30th, at which time a cut will likely be warranted. 

The Bank closed its announcement by noting “we will support economic growth while ensuring inflation remains well controlled”, suggesting that if the economy weakens further, they will likely lower rates in the near future.