BoC Governor Tiff Macklem warned that the economic outlook remains uncertain after the central bank left its rate unchanged on Wednesday.Blair Gable/Reuters
The Bank of Canada held its benchmark interest steady on Wednesday and published a cautiously optimistic outlook that sees the Canadian economy gaining momentum through the back half of the year while the risk of oil-driven inflation fades.
As widely anticipated, the central bank’s governing council opted to keep the policy rate at 2.25 per cent for the sixth consecutive time.
For months, the bank has wrestled with the tough combination of stagnant economic growth and soaring oil prices caused by the war between the United States and Iran. Heading into this rate-decision, things looked better on both fronts.
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“After stalling over the past year, economic growth looks to have resumed in Canada. While U.S. trade policy continues to be a headwind, consumers have been resilient and businesses are adapting,” Governor Tiff Macklem said at a press conference after the announcement.
At the same time, global oil prices have eased from the highs reached in April and May, lessening the risk that high gasoline prices will morph into broad-based inflation.
Mr. Macklem said the current interest rate level remained “appropriate” for the circumstances, although he warned that economic uncertainty remains high, with oil prices dependent on unpredictable developments in the Middle East.
Over the past week, the resumption of fighting between the U.S. and Iran around the Strait of Hormuz has pushed the price of a barrel of Brent crude up around US$10 to US$85. That’s a long way from the US$120 reached in April, but heading in the wrong direction.
“Let’s be frank, the situation in the Middle East remains very volatile,” Mr. Macklem said. “It looks like it’s a long way from being resolved. And so yes, if the oil prices go higher and they remain higher, there may well still be a need for consecutive [interest rate] hikes.”
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Rate cuts could also be on the table if the rebound in the domestic economy fizzles, he added. Neither hikes nor cuts are the bank’s base-case scenario, he said, but “there are risks on both sides.”
Financial markets expect the Bank of Canada to remain on hold over the next two meetings, in September and October, with the possibility of a quarter-point hike in December, according to Bloomberg data. Most Bay Street economists expect the bank to remain on hold until 2027.
“The recent run of firmer data, as well as robust financial markets, has the BoC a bit more upbeat on the near-term outlook, but not enough to convincingly shift the medium-term view,” Douglas Porter, chief economist at Bank of Montreal, wrote in a note to clients.
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“The volatility in energy prices is also keeping the BoC on high alert, as that’s the X factor on the near-term inflation outlook. The Bank is firmly on hold, and we expect them to remain there through the rest of 2026 – assuming that oil prices don’t flare dramatically higher from here,” he said.
Rising gasoline prices pushed annual consumer price index inflation to 3.2 per cent in May – the first time it’s been above the top end of the Bank of Canada’s 1-per-cent to 3-per-cent control band since late 2023.
So far, however, this has not produced broader inflationary pressures, the bank said. Core measures of inflation that strip out volatile prices remain close to the 2-per cent target. And while some companies are passing war-related costs along to their customers, this is being offset by downward pressure on other prices – particularly for services – owing to broader economic weakness, the bank said.
Central bank forecasters expect headline inflation to decline to around 2.5 per cent by August, before moving back to two per cent by early 2027. That outlook depends on benchmark oil prices falling back to around US$75 and gasoline refinery margins tightening.
Derek Holt, head of capital market economics at Bank of Nova Scotia, warned in a note to clients that the central bank may be underselling the inflation risks.
“Industrial prices continue to point toward lagging pass-through effects into core consumer price inflation,” Mr. Holt wrote. “Shipping costs are also soaring, yet ignored. Then we have productivity adjusted employment costs that are soaring as costs are outstripping moribund productivity growth.”
When it comes to economic growth, the Bank of Canada is projecting a small but meaningful rebound after two quarters of declining gross domestic product that prompted debates about whether the Canadian economy was in a recession.
Exports are getting a boost from high oil prices, and they could be further buoyed by a weak Canadian dollar – which makes Canadian products more attractive to foreign buyers – and by U.S. demand for the raw materials tied to the massive build-out of AI data centres, the bank said.
Meanwhile, business investment is starting to pick up, consumer and government spending remains robust, and the housing market – while still weak – is becoming less of a drag on the overall economy.
“When we talk to companies, when we look at the change in momentum, we do think it is sustainable,” Mr. Macklem said of the improving growth picture. “If exports stall, investment will stall, hiring will slow down. So, there are some risks. But increasingly the economy is looking like it is in expansion.”
In its quarterly Monetary Policy Report, published alongside the rate decision, the bank trimmed its full-year 2026 GDP growth projection to 0.7 per cent from 1.2 per cent owing to the unexpected decline in the first quarter. But forward-looking growth projections were revised up.
The bank expects GDP to grow at an annualized rate of 2.5 per cent in the second quarter. And it sees 1.8 per cent GDP growth in both 2027 and 2028, up from the previous projection of 1.6 per cent and 1.7 per cent respectively.
There are still plenty of risks. Slow population growth, tied to the federal government’s immigration restrictions, remains a drag and the housing market is vulnerable.
“The overhang of unsold condominiums in Vancouver and Toronto, along with affordability issues, could mean that the recovery in housing activity is slower than expected,” the bank said in the MPR.
And there’s the continuing uncertainty about the future of U.S. trade policy. On July 1, the Trump administration decided not to extend the United States-Mexico-Canada Agreement for another 16 years. That means the trade pact moves into a period of annual reviews until 2036, while the threat of withdrawal or higher tariffs remains.
“The economy is adjusting to U.S. tariffs, and the impact of trade‑related uncertainty is assumed to gradually fade,” the bank said. “However, the United States could announce further trade measures. Uncertainty could also persist for longer than assumed, weakening business investment and household spending.”