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The Bank of Canada is facing a tricky interest rate decision this week against the backdrop of roiling financial markets, a federal election and erratic U.S. trade policy that makes economic forecasting almost impossible.
Financial markets and analysts are split on whether the central bank will deliver another quarter-point interest rate cut on Wednesday, which would take the benchmark policy rate to 2.5 per cent, or pause its easing cycle after seven consecutive cuts.
Policy makers are holding their cards close to their chest. In a speech last month, Governor Tiff Macklem said the extreme uncertainty caused by U.S. President Donald Trump’s shifting tariff policy means the Bank of Canada can’t rely on normal forecasts and needs to remain nimble.
“We need to set policy that minimizes the risk. That means being less forward-looking than normal until the situation is clearer. And it may mean acting quickly when things crystallize,” he said.
The economic ground has continued to shift under Mr. Macklem’s feet. The U.S. placed crippling tariffs on all imports from Canada in early March, but then granted an exemption for goods that comply with the continental free trade agreement. Tariffs on automobiles, steel and aluminum remain in place.
Mr. Trump then announced eye-watering tariffs on dozens of other countries in early April but backed down a week later and offered a 90-day pause in the face of a massive sell-off in stocks, U.S. Treasury bonds and even U.S. dollars. Meanwhile, the President ratcheted up his trade war with China, pushing tariffs on Chinese goods to an astonishing 145 per cent.
Wherever Mr. Trump lands in his attempt to remake the global trading system, the nature of the shock will entail tough choices for the Bank of Canada. Trade wars produce what economists call a “stagflation” shock. Tariffs hurt economic growth and employment, but they also increase prices as companies pass along higher costs to consumers.
“The problem is they’ve got a slowing economy in the United States, they have a slowing economy in the world, they have a slowing domestic economy, all of which would indicate that you would go at least to the bottom end of what you think is the neutral range on interest rates,” former Bank of Canada governor David Dodge said in an interview. (The central bank estimates neutral is between 2.25 per cent and 3.25 per cent).
“But at the same time, what is going on is obviously creating very large inflationary pressures, coming both from the tariffs themselves and from the disruption that is coming and is having an impact … And you have the responsibility to stabilize prices which would tell you to keep rates the same or push them up,” Mr. Dodge said.
Amid all the uncertainty, he added, “there is actually a great advantage to doing nothing.”
Interest rate swap markets, which capture investor expectations about monetary policy, reflect the two-sided nature of the risks. They’re pricing in a roughly 60-per-cent chance the Bank of Canada holds steady and a 40-per-cent chance it cuts – a more even split than ahead of recent rate decisions.
The economic data doesn’t provide a clear path forward, either. The annual rate of inflation leapt to 2.6 per cent in February from 1.9 per cent in January, moving above the central bank’s 2-per-cent target for the first time in seven months.
But the increase was partly caused by the end of the GST and HST tax holiday, a one-time event. And there are other idiosyncratic factors that could muddy headline inflation numbers in the coming months, including the end of the carbon tax and the steep drop in gasoline prices in recent months.
In an unusual turn of events, Statistics Canada will report March inflation numbers on Tuesday, a day before the Bank of Canada’s rate decision.
Other economic data has been mixed. Recent gross domestic product readings have come in stronger than expected, suggesting the Canadian economy entered 2025 on a solid footing. But jobs numbers have sagged and consumer and business sentiment has crumpled, according to central bank surveys, as worries about a trade war with the United States have become widespread.
“At risk of oversimplifying, the Canadian situation can be nicely summed as backward-looking data is good, forward-looking indicators are bad,” a team of Toronto-Dominion Bank rate strategists, led by Andrew Kelvin, wrote in a note to clients.
“Normally that would be a tricky balancing act for a forecaster, but the Bank was so kind as to tell us that they were going to focus on the backward-looking hard data. The 90-day global tariff ramp down really just helps cement the pause.”
By contrast, Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, sees the Bank of Canada cutting again this week, given the many downside risks to the economy.
“Truth be told, the decision could go the other way, given that the economic consequences of waiting until June would not be material. The advantage of moving now is that the accompanying Monetary Policy Report can’t avoid talking about the downside risks to growth. With that gloomy backdrop, we could all use a little cheer from a 25 basis point Easter present from our central bankers,” Mr. Shenfeld wrote in a note to clients.
On one front, the Bank of Canada’s life has gotten easier in recent weeks. The Canadian dollar has strengthened markedly against the U.S. dollar, rising to over 72 US cents from below 70 US cents in March. That increase makes imported goods cheaper, helping offset some of the inflationary impact of Ottawa’s countertariffs on U.S. products.
The Bank of Canada will publish its quarterly Monetary Policy Report alongside the rate decision. This document usually includes forecasts for inflation and economic growth. However, Mr. Macklem suggested last month that the bank may avoid publishing a central scenario given the uncertainty – something it last did in the opening months of the COVID-19 pandemic.