MNI BOC WATCH: Macklem's Hold Signal Tested By Iran Gas Bump

The Bank of Canada is seen keeping its benchmark interest rate unchanged Wednesday, with a focus on how Governor Tiff Macklem describes inflation risks deriving from the Middle East conflict fitting in with his view that slack generated by U.S. tariffs allows him to remain on hold. 

All 20 economists surveyed by MNI see the overnight rate staying at 2.25%, the low end of the Bank's neutral range and where it's been since October. The decision is due at 9:45am EST (1345GMT).

Fighting around Iran so far is regarded by investors as boosting Canada's inflation and economic growth by a few tenths of a percent, not enough to disrupt the Bank’s baseline view that 2026 is a year of slow adjustment to U.S. tariffs. That leaves scope for inflation to stay in the Bank's 1% to 3% target range unless there is a long spell of high gasoline prices. (See: MNI INTERVIEW: BOC Rate Hike Odds Rise With Higher Oil- ATB)

SECOND ROUND EFFECTS

Investors are checking for whether the Bank's statement adds language about the potential for a short-lived gasoline price bump that they can look through, concern about second-round inflation pressure, or for price expectations to ratchet up. While headline inflation has been near 2% for a while, core indexes only recently slowed from about 3% to around 2.5%. 

Canada is a major exporter of oil and gas so higher prices also provide potential upside from higher incomes, exports and investment. The Bank estimates the economy has slack of up to 1.5% of GDP and growth this year at about 1%, enough to keep inflation near 2%. The economy also shrank at a 0.6% annualized pace in the fourth quarter, and employment plunged in February, suggesting even more room. 

Deputy Governor Sharon Kozicki’s recent speech supported the view that supply-driven shocks can lead to more policy tradeoffs and reliance on flexibility in meeting the inflation target based on the intensity and duration of different pressures. One uncomfortable situation can be where "monetary policy needs to be tightened even when the economy is weak," she said. (See: MNI INTERVIEW: Trade Woes Mean BOC Stagflationary Risk-CD Howe)

Donald Trump's tariffs on autos, steel and aluminum and his threat to reject a free trade deal later this year is also a major downside risk making it difficult to signal a rate hike to get ahead of inflation pressure. Still, policymakers worldwide are smarting from their decision to leave rates low as prices surged following Russia's invasion of Ukraine.

PREPARED TO RESPOND

Bond investors aren't so sure, with two-year Canada yields up to 2.75% Friday from 2.4% at the end of last month. 

Macklem said after a March 4 speech the policy rate remains appropriate as long as the economic outlook holds up. "If the situation changes, and in particular if that has a material effect on the outlook, we are prepared to respond," he said.