The BoC sets a lower bar for higher rates
The Bank of Canada left its policy rate at 2.25% this afternoon, a seventh consecutive hold that surprised no one.
All 30 economists polled by Bloomberg expected no change, while swaps had similarly predicted the policy rate would remain untouched. As we argued in our preview, trade risks and inflation data are pulling in opposite directions, leaving the Governing Council little option but to wait. That said, it is interesting that the assessed balance of risks skews hawkish at the margin, an outcome that is helping to push the loonie higher post-event. But despite the market reaction, and the BoC’s view of present conditions, we would be wary of pencilling in any policy tightening just yet.
Admittedly, since the July meeting, Q2 GDP has printed at 3.3% annualised, well above the Bank's 2.5% projection, with Q1 revised into positive territory, while unemployment fell to a two-year low of 6.4% in July.
Headline inflation, meanwhile, rose to 3.0%, the top of the Bank's control range, underpinned by gasoline, up 25.7% on the year. With that energy impulse unlikely to fade in the short term, given renewed US-Iran hostilities which have left the Strait effectively closed to commercial shipping and pushed WTI back above $90, the Governing Council has understandably expressed concerns over upside inflation risks.
Against this, however, the collapse of US-Canada trade talks on August 21st has upended the growth outlook, a point recognised in both the policy statement and Governor Mackelm’s press conference comments.
Washington has already announced 50% tariffs on Canadian vehicles, steel and agricultural products; Ottawa's retaliation is set to take effect on September 8th, and President Trump has threatened to increase duties on additional Canadian products from January. That amounts to a significant demand shock, landing on an economy only just emerging from a year of stagnation. The Governing Council described present conditions, saying that “demand for labour remains subdued and indicators point to continued excess supply in the economy”. To us, that indicates little scope for embedding inflation pressures beyond energy components, even without considering forward-looking risk.
As such, absent seeing clear evidence of broadening price pressures in the data, we think the Governing Council bias will be to leave rates untouched.
We would also note, subdued underlying inflation has certainly been the case in recent months. Core-median CPI growth now sits at 2.0%, and core-trim at 1.9%, with few signs of an uptick, meaning there is little reason to overreact to gasoline-driven headline inflation. Moreover, Canadian 10-year yields are now some 36bp higher than at the start of July, delivering some of the tightening the Bank need not provide itself. As we see it, this onus is squarely on the data to justify policy tightening.
That bar is arguably lower given the Bank’s latest rhetoric, but recent publications are still some distance from meeting that threshold, given the uncertain economic outlook.
Still, for the loonie, this is a positive development at the margin. USDCAD now trades in the mid-1.38s, breaking below 1.39 following today’s decision, but only by enough to revisit Monday’s lows. With markets pricing roughly a two-in-three chance of a Fed hike later this month against a BoC firmly on hold, rate differentials favour the greenback for now, while haven demand as Hormuz stays shut points the same way. Friday's North American jobs reports and the start of counter-tariffs are the next major tests. Absent a marked improvement in the trade backdrop, we continue to see 1.40 as the obvious near-term target for USDCAD.