Introduction to the Bank of Canada’s Interest Rate Decision
The Bank of Canada recently released documents showing that some members were questioning whether the central bank’s benchmark interest rate is low enough to support the Canadian economy through U.S. tariffs. The documents were from the meetings leading up to the decision on July 30 to hold the policy rate steady at 2.75 per cent. The central bank’s governing council was focused on how U.S. tariffs and the global trade "rewiring" were affecting inflation and the wider Canadian economy.
The Impact of U.S. Tariffs on the Canadian Economy
The Bank of Canada’s decision to hold the policy rate steady arrived just a couple of days before U.S. President Donald Trump increased base tariffs on Canada to 35 per cent, while maintaining an exemption for goods compliant with CUSMA. Despite the ongoing uncertainty, monetary policymakers noted that there were some signs of economic resilience heading into the rate decision. The deliberations showed that some members wondered if the Bank of Canada had already provided "sufficient support" to guide the economy through its tariff transition.
Rate Cuts and Their Effect on the Economy
The central bank cut its policy rate seven consecutive times from June 2024 to March of this year in a bid to boost the economy as inflation showed signs of coming back under control. Economists say that much of the impact from a monetary policy decision tends to take effect a year or more after the move, so many of those rate cuts are just now starting to stimulate the economy. The Bank of Canada governing council wondered whether cutting rates now, only for the economy to recover on its own, would only end up fueling inflation down the road.
The Risks of Further Easing
Given the lagged effects of monetary policy, there was a risk that further easing might take effect only as demand was recovering, which could add to price pressures. Some forecasters, including RBC, have no further interest rate cuts in their base-case outlooks. Others on the Bank of Canada’s governing council felt that signs of slack emerging in the economy could warrant additional rate cuts, particularly if the labor market started showing more weakness.
The Impact of Tariffs on Inflation
The governing council noted that none of the scenarios showed a "sharp rise in inflation." Monetary policymakers said in deliberations that the impact of tariffs on consumer prices "appeared to be modest so far," but those effects were only just starting to show up in the data. Members judged the risks to inflation to be elevated given evident pressures on underlying inflation and the uncertainty around the impacts that tariffs and trade disruptions could have on Canada’s economy over time.
Conclusion
The Bank of Canada will get a fresh look at inflation figures for July and August ahead of its September 17 interest rate decision. The central bank’s decision to hold the policy rate steady was a cautious move, taking into account the ongoing uncertainty and the potential risks of further easing. As the Canadian economy continues to navigate the challenges posed by U.S. tariffs, the Bank of Canada will need to carefully consider its next moves to ensure that the economy remains stable and inflation is kept under control.
