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Bank of Canada Holds Policy Rate Amid Middle East Uncertainty

Canadian Economics

By: Walter Bolduc

    

The Bank of Canada held the target for the overnight rate at 2.25 per cent, with the Bank Rate at 2.50 per cent and the deposit rate at 2.20 per cent.

  • The Bank held the overnight rate at 2.25 per cent, with the Bank Rate at 2.50 per cent and the deposit rate at 2.20 per cent, the third consecutive hold since October 2025.
  • The war in the Middle East has driven sharp increases in global oil and natural gas prices and tightened financial conditions, with bond yields rising, equity prices declining, and credit spreads widening.
  • The effective closure of the Strait of Hormuz is disrupting energy supply and could create transportation bottlenecks affecting other commodities, including fertilizer.
  • Prior to the conflict, global growth was tracking at approximately 3 per cent, consistent with the January Monetary Policy Report projection.
  • Canadian GDP contracted at an annualized rate of 0.6 per cent in the fourth quarter of 2025, weaker than the Bank anticipated in January, though the decline was driven primarily by a large inventory drawdown rather than a shortfall in final demand.
  • Domestic demand expanded by more than 2 per cent in the fourth quarter, supported by consumer and government spending, while housing markets remained weak.
  • The labour market softened further, with employment gains recorded in late 2025 largely reversed in the first two months of 2026 and the unemployment rate rising to 6.7 per cent in February after the economy shed 84,000 jobs.
  • CPI inflation eased to 1.8 per cent in February, down from 2.3 per cent in January, with core inflation measures settling close to the 2 per cent target.
  • Food price inflation slowed in February but remained elevated relative to broader price trends.
  • Rising global energy prices have already pushed gasoline costs higher and are expected to lift total CPI inflation in the months ahead.
  • Governing Council assessed that risks to growth are tilted to the downside, while inflation risks have increased because of higher energy prices.
  • The Canada/US dollar exchange rate has remained relatively stable despite the broader tightening in global financial conditions.
  • The next rate announcement is scheduled for April 29, 2026, and will be accompanied by the quarterly Monetary Policy Report.

Key Insights

A sluggish start to 2026 and rising energy costs left limited policy room. The Canadian economy has shed over 100,000 jobs over the first two months of 2026, mostly reversing gains seen in the fourth quarter of 2025, and advance estimates from Statistics Canada indicate the economy showed no growth in January. At the same time, surging oil prices are expected to push headline CPI higher over the next few months. This has narrowed the Bank’s options today, as a cut risks increasing inflation even further, while a hike would restrain growth in an already soft economic environment.

The Middle East conflict poses supply risks beyond crude oil. The Bank flagged disruptions to natural gas and fertilizer supply tied to the effective closure of the Strait of Hormuz. Oil prices have risen around 40 per cent in under three weeks, with Brent crude now trading over US$100 per barrel and Canadian gasoline averaging $1.65 per litre. If transportation bottlenecks persist, the passthrough to food and input costs could be broader than higher energy prices alone suggest.

We expect the Bank to hold steady throughout the remainder of the year, though there is considerable risk to our outlook. Despite a difficult start to the year for the Canadian economy, household spending expanded a healthy 1.7 per cent in the fourth quarter of 2025, and we still expect economic conditions to stabilize throughout 2026, reducing the need for a rate cut to stimulate the economy. At the same time, we see conflict in the Middle East and intermittent supply disruptions persisting through 2026, which will keep oil prices elevated through much of the year. Although this might point toward an eventual rate hike, we think the most likely outcome is that the Bank will maintain its policy rate for the remainder of 2026 as it continues to assess how the Canadian economy adjusts to global headwinds. However, there are significant risks to this outlook. The impact of U.S. tariffs, trade policy uncertainty, and the conflict in the Middle East remain highly unpredictable and could shift the trajectory of monetary policy in the coming months.

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