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%, its second consecutive pause.
The BoC continues to make it clear that its primary focus going forward will be to assess the balance between the opposing impacts of a trade war on inflation, with lower inflationary pressures stemming from weaker growth and higher inflationary pressures arising from uncertainty, tariffs, counter-tariffs, and supply chain disruptions.
The overall message from today’s decision is that the economy is “softer but not sharply weaker” while there is “some firmness in recent inflation data”. When balancing the two conflicting developments since the April meeting, the Bank chose to prioritize the latter.
This clearly means that the BoC will put more weight on current inflation than on future inflation, and that 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 demonstrated the disruptive impact of high inflation on the Canadian economy, and the BoC is likely to avoid 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 depend on US trade policies, the magnitude of the slowdown in the Canadian economy, especially whether we see further job losses, 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.
The BoC left its policy rate unchanged at 2.75%. The opening statement of the press conference makes it clear that, given the high level of uncertainty, the Governing Council “will proceed carefully”. This seems to suggest that when in doubt, staying on hold to gain more information is now the default path. Moreover, it also means that the Governing Council will be “less forward-looking than usual”, privileging current data points rather than projection.
With that in mind, the statement also adds that “we 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.” In today’s context, in balancing the “softer but not sharply weaker” with the “some firmness in recent inflation data”, it is clear that the Bank is focus more of the latter.
The BoC notes that “while the global economy has shown resilience in recent months, this partly reflects a temporary surge in activity to get ahead of tariffs”. The Bank notes that domestic demand remains relatively strong in the US and that inflation has moderated but remains above 2%. In Europe, the economy is supported by exports and increased military spending, while in China, the economy “economy has slowed as the effects of past fiscal support fade”.
The BoC also notes that in financial, “risk assets have largely recovered and volatility has diminished, although markets remain sensitive to US policy announcements.
The Canadian economy was slightly stronger than expected in Q1, but the growth composition was as expected. “The pull-forward of exports to the United States and inventory accumulation boosted activity, with final domestic demand roughly flat.” The Bank also adds that “the economy is expected to be considerably weaker in the second quarter, with the strength in exports and inventories reversing and final domestic demand remaining subdued.”
Inflation is slightly stronger than the Bank had expected. The BoC notes that its “preferred measures of core inflation, as well as other measures of underlying inflation, moved up” and that households expected that tariffs will increase prices, while businesses intend to pass the higher cost. The Bank adds that it “will be watching all these indicators closely to gauge how inflationary pressures are evolving.”
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Independent Opinion
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