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The Bank of Canada kept its key interest rate at 2.25 per cent as expected on Wednesday and said any changes in the rate could be small if its projections for the economy held true.
Governor Tiff Macklem said the key rate is probably at about the right level if the economy follows the central bank’s projections, though he didn’t rule out future adjustments depending on how the risks play out.
“If the economy evolves broadly in line with the base case, changes in the policy rate can be expected to be small,” he said.
“However, uncertainty is unusually elevated and there are many possible outcomes. Monetary policy may need to be nimble.”
The bank said it is closely monitoring the impacts of the war in Iran — which has sent the price of energy way up — and trade policy uncertainty. For now, the bank is “looking through” the impact of sky-high oil prices on inflation, though if oil prices stay high for longer, rate hikes could be in order.
The bank said the overall effect in Canada of the war will be modest. High oil prices benefit Canada by increasing export revenues while squeezing businesses and consumers.
Inflation in April is expected to shoot up to about three per cent, from 2.4 per cent in March, while averaging around 2.3 per cent for this year, but is expected to come back down to the bank’s two per cent target by early next year. The bank lifted its 2026 growth forecast to 1.2 per cent, from the 1.1 per cent it had predicted in January.
But at this point, inflation was mostly contained to energy prices, and long-term inflation expectations remained anchored, Macklem said.
“So far, there is little evidence that higher oil prices have fed through to other goods and services prices more broadly,” Macklem said.
Near-term inflation expectations have risen due to higher energy prices and elevated food prices, but long-term inflation expectations remain anchored, he noted.
There is a risk that inflation expectations are not as well anchored as they were before the COVID-19 pandemic, Macklem said, noting public unhappiness when inflation spiked to 8.1 per cent during the pandemic.
The bank said it was assuming that U.S. tariffs would stay unchanged while the price for a barrel of oil would dip to $75 US a barrel by mid-2027.
“If oil prices continue to increase, and particularly if they remain elevated, the risk that higher energy prices become ongoing generalized inflation increases,” said Macklem.
“If this starts to happen, monetary policy will have more work to do — there may be a need for consecutive increases in the policy rate.”
While oil prices could lead to future hikes, the Bank of Canada outlined another factor that complicates the picture: the ongoing trade war.
The Bank of Canada is keeping its key lending rate at 2.25 per cent, saying future changes could be small if its economic projections hold true. However, Governor Tiff Macklem also warned that this is a time of uncertainty and that there could be future consecutive rate hikes if oil prices stay high and increase inflation.
If the United States hits Canada with sharper trade restrictions in the wake ofthe upcoming CUSMA review, Macklem said the bank may need to cut the policy rate further to support the economy.
Carolyn Rogers, the central bank’s senior deputy governor, said the oil crunch presents the biggest short-term impact, but trade tensions have a more long-term impact.
CIBC economist Avery Shenfeld says the fact that the Bank of Canada mentioned both of these factors signals they’re likely planning to hold steady for some time.
“That sounds like a central bank that thinks it could stand pat, as it cites both reasons why it might have to cut (due to trade restrictions) or hike (if energy prices spark a broader inflation),” Shenfeld said in a note to clients.
The next monetary policy decision is on June 10 and money markets do not expect a rate change, but they are pricing in one 25-basis-point hike in October.
