The Bank of Canada is in a tough spot, and you could almost feel the tension in today’s decision to pause its policy rate at 2.75% for the second straight meeting.
The decision did not come as a surprise. We were expecting a rate pause today, but have noted that the Bank could have justified a cut (more below).
In today’s statement three main things were highlighted:
- Weaker growth is expected. The first quarter of 2025 was flattered by some front-loading effects, and the Bank expects the economy “to be considerably weaker” in the second quarter.
- Sticky inflation. “The Bank’s preferred measures of core inflation, as well as other measures of underlying inflation, moved up.”
- Heightened uncertainty. President Trump’s on and off again approach and shift to bilateral agreements are making it tough to forecast the future. “Uncertainty remains high,” and the Bank is electing to wait for more data before its next move.
Not a great combo. The economic slowdown calls for a rate cut, but tariffs push prices higher and the Bank’s job is to keep inflation in check. Balancing the ‘flation’ with the ‘stag’ in the current stagflation environment is a delicate dance. Heightened uncertainty is an added twist, with the Bank taking a ‘wait and see’ stance in response to not knowing what’s next.
A “clear consensus” to pause, but future cuts still on the table
April’s decision seems to have been a close call. As for today, Macklem called the pause “a clear consensus.” However, there was some guidance that future rate cuts could be coming: “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 US tariffs and uncertainty, and cost pressures on inflation are contained.”
Inflation spoils the rate cutting party
The deal breaker appears to be inflation, which is still running too hot for comfort. True, headline inflation is now below 2%, but that’s because of the carbon tax removal. The Bank sees through that, just like they did with the GST/HST holiday. Inflation pressures based on two of the Bank’s preferred core metrics are holding uncomfortably high at around 3%.
Why wait?
These are never easy decisions, but our view is that the Bank could have justified an ‘insurance’ cut based on several factors—a weakening economic outlook, a softer labour market and cooling wage pressures. Some may point to the sturdy Q1 GDP reading, but we see this as mainly front-loading to get ahead of the tariffs (inventory build, higher exports). The domestic economy and labour market are weak, and growth will slow. As for inflation, we think that pressures will eventually fade with a softening economy and shelter costs adding less. More to the point, we see more cuts as inevitable down the road. Why not now?
Faced with uncertainty, the Bank’s approach is now less forward looking and more data dependent. The press conference remarks had a heavy focus on recent data, dissecting the latest CPI and employment readings. From the press conference remarks: “Faced with unusual uncertainty, Governing Council is proceeding carefully, with particular attention to the risks. This means we are being less forward-looking than usual [emphasis ours].”
Give me more time
The Bank doubled down on its ‘wait and see’ approach today, as they try to sort out how tariffs are impacting the economy and inflation.
Keep your eye on inflation expectations. In the April summary of deliberations, some council members noted that as long as inflation expectations remain ‘anchored’ the Bank of Canada can support growth through rate cuts. In other words, if surveys suggest that longer-term expectations are contained, further rate cuts are likely. Macklem’s statement spoke today about looking at ‘how inflation expectations evolve’ as a key consideration.
What’s next
We maintain our forecast for the Bank’s policy rate to finish at 2% by year end, as the Bank responds to the softer outlook. The exact timing, as always, will depend on the data. But we don’t see the Bank cutting beyond that, meaning it has already done the heavy lifting in bringing the rate down. The next interest rate announcement is scheduled for July 30, 2025.
Bank of Canada not to the rescue
One thing that has been abundantly clear to us since the trade war started is that the Bank of Canada’s main weapon—rate cuts—can only do so much during this trade war.
Tiff Macklem has said as much in the last two rate announcements. He was less explicit today in the formal remarks, dropping the phrase from April: “Monetary policy cannot resolve trade uncertainty or offset the impacts of a trade war.” But the undertones are there, and the final paragraph points to its emphasis on price stability:
“We are focused on ensuring that Canadians continue to have confidence in price stability through this period of global upheaval. We will support economic growth while ensuring inflation remains well controlled.”
This begs the question. If the Bank of Canada isn’t going to slash its policy rate as growth slows, what will get Canada’s economy going? We’ve long argued that the next leg of growth will need to be driven by capital investment. The GDP per capita problem is, for the most part, an investment problem. The new federal government has said they are working on it, and the PM and premiers met this week to discuss prioritizing national projects to help bring back investment.
We wait for action on this front, as Tiff Macklem and company have been clear they are not coming to the rescue with large rate cuts.
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