Bank of Canada Pause Highlights Conflicting Signals Across Economy
Canada’s central bank’s decision to hold its key interest rate is the right thing to do with the economy facing significant uncertainty as the war in Iran enters its third week, say economists.
On Wednesday, the Bank of Canada maintained its key interest rate at 2.25 per cent, noting that war-related disruptions to oil and natural gas supplies will drive up short-term inflation.
“I think the smart thing for them to do is to sort of sit on their hands here, give themselves maximum optionality,” says Andrew Kelvin, head of Canadian and global rates strategy at TD Securities.
“It’s hard to predict the path of the economy, even in the best of scenarios, with the duration of the conflict in the Middle East still highly unknown.”
The rate hold was widely expected, as there have been a lot of “cross currents” hitting the economy, on both the inflation and growth side, says Jason Daw, head of North America rates strategy at RBC.
“Now another supply shock added into that oil further complicates the outlook,” says Daw.
Kelvin says the bank appears focused on financial conditions in equity and bond markets, as well as the potential for supply chain disruptions.
At the same time, as oil prices rise and Brent crude hits US$110 a barrel on Wednesday, the central bank is trying to prevent inflation from accelerating again, Kelvin says.
He noted the Bank of Canada faced similar uncertainty during its January rate decision, when it also chose to hold.
“I’m just going to suggest that uncertainty has not declined in the last few months.”
Inflation worries and a hint at a rate cut: Economists react to BoC rate hold
Rates path remains unclear
Daw says the current environment makes further tightening more likely than cuts.
“What we know from the oil shock that we’re facing is that inflation is going to be higher on headline CPI. Whether there are second-round effects that filter into core measures and into the labour market,” says Daw.
“The outlook for growth could be more neutral. It could be slightly positive, slightly negative, with higher oil prices. But we’re going to have to wait to see how the evidence plays out.”
Kelvin says if the bank needs to hike interest rates in the coming months, it can, because it has not tied its hands. He said the bank will be watching household spending as a key signal for where the economy and prices are headed.
“If households find they need to pull back a little bit more, particularly in the context of falling population growth, that’s something that I think the Bank of Canada would feel they might need to provide a bit more stimulus in response,” says Kelvin.
He says the U.S. Federal Reserve’s rate decision, expected Wednesday, is unlikely to have a major impact on Canada.
“We’ve seen a lot of cases historically where the BoC is willing to go in its own direction and do its own thing based on domestic fundamentals, and specifically a stronger inflation mandate compared to the Fed’s dual mandate.”
Loonie decline expected
The Canadian dollar’s decline was not surprising, given markets were anticipating the rate hold and the bank did not rule out further hikes this year, Kelvin says.
He says markets have already priced in a rate hike by the end of 2026, and for the loonie to strengthen, that expectation would need to fade.
“And the Bank of Canada, we need to see, say something a bit more declarative, I would say, for markets to really give up on the idea that high oil prices are going to lead to higher policy rates,” says Kelvin.
This article was first reported by BNNBloomberg
