MNI BOC WATCH: Core Inflation Too Hot For Returning To Cut

Canada's central bank is seen by a majority of economists as leaving interest rates unchanged for a second meeting Wednesday after core inflation moved above the target band and growth held up in the early days of the U.S. trade war.

Thirteen economists surveyed by MNI see the overnight rate staying 2.75% in a decision due at 9:45am EST on June 4, compared with eight seeing a quarter-point reduction. Several forecasters at Canada's biggest banks switched to a hold after Friday's data showing GDP grew at a 2.2% annualized pace in the first quarter, while traders made that move after a May 20 report showed the Bank's two preferred core indexes quickening past 3%.

Monetary policy is neutral after seven straight reductions between June and March to lead the G7 on stimulus before Governor Tiff Macklem paused in April. With U.S. President Donald Trump imposing and then easing tariffs, Macklem says he can't be as forward-looking and must see whether the biggest danger is inflation taking off or the economy falling into recession starting this quarter.

Macklem said after the last decision there have been early signs of a milder trade war but since then Trump has shifted back and forth on tariffs globally and on Canada, including a move last weekend to double steel tariffs. Trade war or not, cutting borrowing costs again when it's unclear why core prices have been sticky could put the Bank's reputation at risk again if tariffs create a burst of inflation seen after the Covid rebound.

Faster growth than the Bank's 1.8% first quarter estimate also gives a bit of extra comfort the economy might not fall into a technical recession later this year, which more dovish economists say would require another two or three rate cuts in 2025. Former Governor David Dodge told MNI he shares the view more relief will be needed. (See: MNI INTERVIEW: Dodge Sees BOC Cutting To Low End Of Neutral)

CANNOT AFFORD THE RISK

Macklem has also said he can act decisively if it's clear the economy is breaking in a clear direction. That opens the idea that he could return to a jumbo rate move as was seen through the pandemic if he sits out the next meeting or two and the economy gets bumpy. "Monetary policy cannot resolve trade uncertainty or offset the impacts of a trade war. What we can and must do is ensure that Canadians continue to have confidence in price stability," Macklem said recently. 

Other reasons for patience include the job market and fiscal policy. While unemployment is around the highest since 2017 excluding the pandemic that's also linked to a recent surge in immigration the government is pulling back on, suggesting the potential for rebalancing without rate cuts. Prime Minister Mark Carney won an April 28 election on a plan to boost deficit spending but won't present a budget with the details until the fall, and further spending could ease the load on monetary policy. 

There's no question growth is at risk and Macklem has said such trade disruption hasn't been seen since the 1930s. Canada sends three-quarters of its exports to the U.S. and those suppliers account for one in ten jobs. (See: MNI INTERVIEW: Tariff Uncertainty Means Lower BOC Rates- Ragan)

"Core inflation at 3% and the economy avoiding the worst case scenario (for now) means that policymakers cannot afford to risk their credibility on inflation with a cut at this meeting," said Ben Reitzes at BMO. "However, if growth slows as we expect in Q2 & Q3, look for cuts to resume in the back half of the year."