MNI BOC WATCH: Rate Hold And Cut Maybe Needed On Tariff Hit

The Bank of Canada left its key interest rate at 2.75% for a second meeting Wednesday and signaled a cut can be justified if the U.S. trade war slices domestic growth and inflation remains under control, a shift from the last meeting when Governor Tiff Macklem saw more balanced risks. 

"There was a clear consensus to hold policy unchanged as we gain more information," Macklem said in a statement. "On balance, members thought there could be a need for a reduction in the policy rate if the economy weakens in the face of continued U.S. tariffs and uncertainty, and cost pressures on inflation are contained."

The decision to hold rather than cut was expected by a small majority of economists, by a margin of twelve to eight, and few of them expected such a clear signal of a reduction later this year. Former Governor David Dodge told MNI earlier he sees two or three more cuts in 2025 and most economists with a clear view expect the same. 

The Bank retained some language from earlier decisions about risks of slower growth and hotter inflation from the biggest trade disruption since the 1930s, including a phrase about how policymakers can't be as forward looking because of unpredictable U.S. decision-making. But the statement Wednesday dropped a line from April about being "prepared to act decisively" if the economy moved in a clear direction. 

Effects from the trade war have yet to fully manifest themselves in the Canadian or U.S. economy, the Bank said. "The Canadian economy is softer but not sharply weaker. And we’ve seen some firmness in recent inflation data," Macklem said.

While GDP growth was a bit stronger than expected in the first quarter the Bank expects a drop in the second as gains in exports and inventory accumulation to get ahead of potential tariffs wind down. Officials also pointed to Donald Trump's move in the last week to double steel tariffs as evidence of the need to remain cautious. Canada sends three-quarters of its exports to the U.S. and that accounts for about one in ten jobs. 

Dovish economists say Canada entered a technical recession in the second quarter and the Bank in April laid out two scenarios instead of a regular forecast. In the mild scenario growth stalls in the second quarter and in the harsh one the economy shrinks. 

Consumers and executives see inflation boosting prices according to surveys cited by the Bank. As expected the decision devoted attention to the recent climb in core inflation even as the end of a carbon tax slowed headline CPI. "There is some unusual volatility in inflation, but these measures suggest underlying inflation could be firmer than we thought. Higher core inflation can be partly attributed to higher goods prices, including food, and may reflect the effects of trade disruption," Macklem's statement said.

Both of the Bank's core indexes have quickened past 3%, taking them outside its single goal of keeping headline inflation in the middle of a 1% to 3% band. 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 if tariffs create a burst of inflation as was seen after Covid. The Bank already leads the G7 with seven cuts since last June.

It's not just tariffs clouding the outlook. Prime Minister and former BOC and BOE Governor Mark Carney won’t present a budget until this fall after winning the April 28 election, and he's pledged larger deficits that could reduce the need for monetary stimulus. While Canada's unemployment rate is about the highest since 2017 outside Covid the job market may re-balance as the government curbs record immigration. Some heavily indebted consumers are also being hit with expensive mortgage re-financings.

The benchmark lending rate is around the farthest below the Fed’s benchmark since 1997, yet the country’s dollar has shown a little strength in recent weeks. That diminishes the risk of more expensive imports adding to inflation pressure.

"Faced with unusual uncertainty, Governing Council is proceeding carefully, with particular attention to the risks," he said. "We will continue to support economic growth while ensuring inflation remains well controlled."