Introduction to Canada’s Central Bank Decision
The Bank of Canada (BoC) has decided to hold the overnight rate at 2.75% at its latest meeting. This marks the third consecutive meeting without a change, driven by the bank’s focus on short-term uncertainty. The BoC is prioritizing caution, highlighting persistently elevated inflation and trade uncertainty as potential factors that could provide a short-term boost to the numbers.
The BoC’s Aggressive Rate Cuts
The BoC has been aggressively slashing rates since June 2024, trimming 225 basis points (bps) by last March. This is equivalent to 9 policy cuts over 9 months, making the BoC the most aggressive G10 central bank in terms of easing. The central bank typically believes it takes between 18 and 24 months for a rate decision to realize its full impact in the market. The hold was widely expected, with the market pricing in the odds at less than 50% for further easing in June.
The Bank’s Stance on Inflation
The BoC’s primary mandate is to control inflation, with a target rate of 2.0% and a tolerance band of 1 point. The bank’s preferred Core CPI measures of inflation are currently near or above its 3% upper tolerance band. Any move above this would necessitate even more rate hikes, making cuts counterproductive. The BoC noted that they are being "less forward-looking than usual" due to near-term risks being unpredictable at this time.
Job Market and Inflation
June’s job report showed a sudden boom, although it was met with skepticism. Employment is not the central bank’s primary mandate, but it is an important indicator of future demand sentiment. Jobs tend to be created to handle consumption, and more jobs mean more consumption, which can drive inflation. Rising demand for goods and services is often the primary driver of inflation. The job market’s performance has undermined disinflation hopes, making it a crucial factor in the BoC’s decision-making process.
Trade Uncertainty and Inflation
Trade uncertainty has become a potential headwind for rising inflation, with tariffs pushing import costs higher and producers passing these costs on to consumers. This is driving up prices on various goods and services, contributing to inflation. While this is inflationary in the near term, diverted disposable income will eventually turn into a drag and reduce demand, slowing down inflation.
Future Rate Cuts
While no cuts were expected this week, some experts still expect rate cuts in the future. BMO currently expects two more cuts by the end of the year and another cut in 2026. However, the rapidly shifting and unpredictable environment means that this can change abruptly, making rate relief far from guaranteed.
Conclusion
The Bank of Canada’s decision to hold the overnight rate at 2.75% reflects its cautious approach to interest rates. The bank’s primary concern is persistently elevated inflation, which is influenced by various factors, including trade uncertainty and the job market. While future rate cuts are possible, they are far from guaranteed, and the BoC will continue to monitor the situation closely to make informed decisions about interest rates.
