Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud.
Bottom line
The Bank of Canada held its policy rate unchanged at 2.75%, after cutting seven consecutive times, in line with our expectations.
The overall message from the BoC is little changed compared to the March statement. As such, the BoC reiterates that “Monetary policy cannot resolve trade uncertainty or offset the impacts of a trade war.”
The BoC makes it clear that its primary focus going forward will be to assess the balance between the opposing impact of a trade war on inflation, with lower inflationary pressures coming from the weaker growth and the higher inflationary pressures coming from the uncertainty, tariffs and countertariffs, and supply chain disruptions.
With this in mind, it would be a mistake to think the BoC will lean toward supporting the economy and allow inflation to move above the target. The recent inflationary episode has shown how disruptive high inflation can be to the Canadian economy, and the BoC is likely to avoid a repeat of a similar situation.
What is clear is that the BoC will be less forward-looking in the current context of elevated uncertainty and will be more reactive to income data and events. As such, the BoC mentioned that “it also means we are prepared to act decisively if incoming information points clearly in one direction”.
Overall, we continue to believe that the general direction for interest rates is lower. However, the pace of easing is highly uncertain and will depends on US trade policies, the magnitude of the slowdown in the Canadian economy and the evolution of inflation, especially upside pressures. Nevertheless, as we wrote (see Searching for the terminal rate), lower population growth in 2025 and 2026 will be an important drag on the economy, pushing potential growth and the neutral rate lower. This means that at 2.75%, the current policy rate level will likely become restrictive later this year. Interestingly, the BoC did not lower its estimate of neutral in the MPR, but this is likely because they focus on the “medium to long-term” neutral rate, rather than on the ” contemporaneous ” neutral rate (Searching for the terminal rate for details).
As expected, the BoC left its policy rate unchanged at 2.75%. Moreover, the BoC provided little in terms of guidance on the potential direction of future interest rate decisions. As the opening statement of the press conference states, “faced with pervasive uncertainty, Governing Council will proceed carefully, with particular attention to the risks. That means being less forward-looking than usual until the situation is clearer. It also means we are prepared to act decisively if incoming information points clearly in one direction.”
With that in mind, the statement also adds that “Governing Council will continue to assess the timing and strength of both the downward pressures on inflation from a weaker economy and the upward pressures on inflation from higher costs.” Importantly, the Bank added that “Monetary policy cannot resolve trade uncertainty or offset the impacts of a trade war.”
The BoC notes that the global environment was solid at the end of 2024, but “tariffs and uncertainty have weakened the outlook”. The Bank notes that “he economy is showing signs of slowing amid rising policy uncertainty and rapidly deteriorating sentiment, while inflation expectations have risen”. Similarly, growth has been slowing in Europe and China.
The BoC also notes that financial markets volatility has reached an extreme level and that it is adding to the overall uncertainty. It also adds that “oil prices have declined substantially since January, mainly reflecting weaker prospects for global growth. Canada’s exchange rate has recently appreciated as a result of broad US dollar weakness”.
The Canadian economy is slowing. The Bank notes that “tariff announcements and uncertainty pull down consumer and business confidence”. As a result, we are seeing weaker consumer spending, residential investment, and business spending. Moreover, the uncertainty is also reducing business hiring intentions, leading to weak employment.
The BoC presented two projection scenarios in its April Monetary Policy Report. The decision to publish two scenarios is due to the extreme level of uncertainty regarding the outlook.
Scenario #1: uncertainty is high but tariffs are limited in scope. Canadian growth weakens temporarily and inflation remains around the 2% target.
Scenario #2: a protracted trade war causes Canada’s economy to fall into recession this year and inflation rises temporarily above 3% next year.
The BoC’s current assessment suggests that we could be in between these two scenarios.
Inflation has eased recently but remains higher than at the beginning of the year. The BoC attributes some of the higher inflation in recent month to higher goods price inflation and the end of GST holiday. Going forward, the end of the carbon will reduce headline inflation by 0.7 percentage points for the next year. However, the focus will remain on underlying inflationary pressures. The Bank notes that there are downward pressures (oil prices, slower growth) and upside pressures (tariffs and supply chain disruptions) to inflation. The BoC also notes that short-term inflation expectations has increased but longer term one have been more stable.
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Independent Opinion
The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any organization or person in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication.