Rates Unchanged as Bank Navigates Uncertainty

The Bank of Canada holds rates.

Insights

Uncertain times. The upending of U.S. foreign trade policy has reshaped the outlook for global economic growth and has created enormous amount of uncertainty among businesses and consumers. This makes life especially difficult for the Bank of Canada as it looks to set monetary policy. Inflation has generally eased back to historical trends (shelter prices continue to run hot), offering the foundation for improved economic conditions. The climate for another rate cut in April looked favourable but high uncertainty around the trade war’s direction has caused the Bank of Canada to act more cautiously. The imposition of tariffs threatens to destabilize prices, forcing the Bank of Canada to delay progress towards the neutral rate. We believe tariffs will be confined to a single quarter and impacts on prices will be short-lived. However, with the President constantly throttling tariffs, the difficult task of determining what the next move is has become harder. If the next cut is mistimed as a result, households will be subject to unnecessary pain.   

Between a rock and a hard place. A shifting geopolitical landscape risks transforming Canada’s soft landing into a period of stagflation. Although the Bank of Canada’s primary objective is price stability, it also takes unemployment into consideration when setting monetary policy. Stagflation, a situation of high inflation and low growth creates a challenge for monetary policy. Keeping rates higher is necessary to quell price pressures but by subduing demand, risks stoking the unemployment rate. While lower rates stimulate demand and favour growth, they risk allowing inflationary pressures to resurface. Faced with these competing priorities the Bank of Canada is likely to favour price stability by maintaining higher rates for longer but this risks draining economic growth.

Confidence hits a low. Amid a slew of eye-catching tariff announcements, the outlook among consumers  has understandably worsened, as shown in our latest Index of Consumer Confidence. The index now sits at the lowest point on record. Consumers are more pessimistic about current and future finances, job prospects, and the likelihood of making a major purchase. A similar pattern is evident among businesses. The Index of Business Confidence posted a double-digit decline last month, the last time this occurred was during the pandemic. Underpinning the drop was a steep decline in businesses investment appetite, and a sharp rise in the share of firms expecting their financial position to deteriorate over the coming months. Eroded confidence among businesses and consumers can reinforce economic downturns. A lack of business confidence weighs on investment and hiring, while lower consumer confidence leads to reduced discretionary spending. Less spending among consumers impacts business revenues, while less hiring among businesses hurts household income growth.

For more details about consumer and business trends, please consult our Index of Consumer Confidence and Index of Business Confidence.