The Bank of Canada building is on track to keep the policy rate at 2.25 per cent for the sixth consecutive time.Sean Kilpatrick/The Canadian Press
The Bank of Canada is expected to remain in cruise control this week with lower oil prices and a string of positive economic data providing an easier backdrop for a stand-pat interest rate decision.
Since the start of the U.S.-Iran war in February, the central bank has been pulled in two directions, creating what Governor Tiff Macklem has called a “dilemma” for monetary policy.
The surge in global oil prices drove up headline inflation, raising the prospect that the bank might have to increase interest rates to stop price pressures from broadening.
On the opposite side of the ledger, economic growth stumbled in the first quarter of the year, leading to chatter about a “technical recession” and questions about whether the central bank would need to lower borrowing costs to jumpstart economic activity.
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Heading into Wednesday’s rate decision, the picture has improved on both fronts, leaving the bank comfortably on track to keep the policy rate at 2.25 per cent for the sixth consecutive time.
Benchmark oil prices have fallen from above US$100 a barrel back into the US$70 range, close to where they were when the Strait of Hormuz was closed to tanker traffic in February.
At the same time, Canadian economic data have shown green shoots heading into the summer. Gross domestic product rebounded 0.5 per cent in April after a small contraction in the first quarter; Canada’s trade surplus hit a four-year high in May, with exports buoyed by high commodity prices; and the unemployment rate dipped to 6.5 per cent in June.
The economy is hardly thriving, but recession-talk has been shelved.
“We’re comfortable where we are,” Mr. Macklem said at a meeting of global central bankers in Sintra, Portugal, last week.
“We’re at 2.25, so we’re kind of at the bottom end of our neutral range, providing a little bit of support [to the Canadian economy]. We think it’s about the right level to keep inflation contained.”
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Financial markets expect the central bank to remain on hold through the summer and fall, with one quarter-point hike partly priced in for December, according to Bloomberg data.
That doesn’t mean the central bank is out of the woods. The resumption of strikes between the United States and Iran over the past week has put energy markets on edge, leading to several sharp oil price moves. And uncertainty about U.S. trade policy continues to cloud Canada’s economic outlook.
On July 1, the Trump administration decided not to extend the United States-Mexico-Canada Agreement for another 16 years. The trade deal remains in place until 2036 and negotiations are expected to continue over the summer, but Washington’s refusal to extend the deal lengthens the period of uncertainty for Canadian exporters and leaves the threat of higher tariffs in place should trade talks flounder.
“We’ve got to be humble. There’s a lot of uncertainty out there. Those risks could shift quickly,” Mr. Macklem said in Sintra. “The other part of our message is if the situation changes, we’re prepared to take action.”
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With no one expecting an interest-rate move on Wednesday, most of the focus will be on the central bank’s quarterly monetary policy report, where it will update its forecast for economic growth and inflation.
In the last MPR in April, the bank said it expected GDP to grow 1.2 per cent in 2026 and consumer-price-index inflation to average 2.3 per cent this year.
Thomas Ryan, North America economist at Capital Economics, said he expects the bank to modestly trim its inflation outlook based on the quicker decline in oil prices than expected in the April MPR. That would reinforce the idea that inflation remains largely under control.
Annual consumer price index inflation hit 3.2 per cent in May – the first time it’s topped 3 per cent since late 2023 – as a result of rising gasoline prices. But core inflation measures, which exclude volatile items to capture underlying price trends, fell to around 2 per cent, with few signs that higher energy costs are bleeding into other prices and becoming generalized inflation.
“You’ve got a pretty soft underlying economy, so the risk of reigniting inflation pressures are there, but they’re not that high,” Mr. Ryan said. “There’s not much pressure on the bank to really do anything over the next couple of meetings, barring another shock.”
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While the Bank of Canada appears to be settling into a holding pattern, expectations for U.S. interest rates have changed substantially as the United States has continued to churn out solid growth and hot inflation figures, while new U.S. Federal Reserve Chair Kevin Warsh has struck a more hawkish-than-expected tone in his early appearances.
Markets have gone from pricing in rate cuts from the Fed this year to pricing in at least one hike in the fall, starting in September.
This has strengthened the U.S. dollar against other currencies, including the loonie, which has declined nearly 4 per cent against the greenback since late April. The Canadian dollar had dipped to around 70 US cents in recent weeks, and is now trading at around 71 US cents.
“We do expect it to strengthen a little bit, but the timing is a little bit more difficult to point out right now,” Toronto-Dominion Bank economist Maria Solovieva said of the Loonie.
“Another thing that is weighing structurally on the Canadian dollar is productivity – we are behind the U.S. on that. And what we’re seeing currently in terms of flows of funds into U.S. assets supported by higher interest rate expectations is being offset in the Canadian dollar.”
A weaker foreign exchange rate increases the price of imported goods. But there would likely need to be a bigger and more sustained decline in the Canadian dollar before it would become an inflationary concern for the central bank, Ms. Solovieva said.
The Bank of Canada does not target a specific exchange rate, focusing instead on keeping the annual rate of inflation at 2 per cent.