The Bank of Canada left the benchmark interest rate at 2.75 per cent amid extreme uncertainty over U.S. trade policy and uncomfortably high inflation. Governor Tiff Macklem said there “may be a need” for lower rates if his worries over price pressures subside. 

Impossible to predict: The Bank of Canada opted against a typical forecast and instead published three scenarios based on the status quo and escalation and de-escalation of U.S. President Donald Trump’s economic warfare. The outlook attached to the current set of tariffs and retaliatory tariffs has gross domestic product contracting at an annual rate of 1.5 per cent in the second quarter, compared with growth of 2.2 per cent in the first quarter. 

The see-saw reflects the surge in Canada-U.S. trade that occurred as companies raced to stockpile ahead of tariffs before Trump’s return to the White House, and the inevitable collapse as duties came into effect. The Bank of Canada’s “current tariff scenario” sees growth at an annual rate of one per cent in the third quarter, suggesting there’s enough momentum in the economy to keep a recession at bay. 

Excess supply: Macklem said there was a “clear consensus” on the policy committee to leave the benchmark rate unchanged. There is little clarity on what the central bank might do next, although policymakers hinted at some doubt over the economy’s ability to withstand Trump’s tariff assault. 

The new quarterly monetary policy report said trade tensions have resulted in “excess supply,” by which the central bank means the economy theoretically could generate more output without stoking inflation. That’s evident in the labour market, where the jobless rate has climbed to around seven per cent, indicators show that it’s become harder to find a job and wage growth has slowed considerably. “If a weakening economy puts further downward pressure on inflation and upward price pressures from the trade disruptions are contained, there may be a need for a reduction in the policy interest rate,” Macklem said in a statement on the decision.

Price pressures: The “if” in Macklem’s statement is a big one. The economy is weaker, but the indicators the Bank of Canada follows to get a sense of underlying inflation are flashing red. The central bank offered a path that could see those pressures recede. It reckons some of the more recent increases reflect delayed passthrough of a weaker currency in 2024 and previous increases in container shipping costs and agricultural prices. Inflation could slow as those one-time effects begin to fade, especially now that the dollar has appreciated and shipping costs have declined. 

But that assumes tariffs don’t add new price pressures. The central bank said it thinks underlying inflation is around 2.5 per cent, compared with its target of two per cent. That’s a little high, and explains why the bank left interest rates unchanged despite a weaker outlook.