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By Mark Parsons, ATB Economics
Key points
- Policy interest rate stays at 2.25%, as we expected.
- The Bank is walking a tightrope, balancing higher inflation from the war in Iran and weaker growth prospects from re-escalating U.S.-Canada trade tensions.
- We expect the Bank to remain on the sidelines for the rest of 2026.
No surprise this morning. The Bank remains in a ‘wait-and-see’ posture, keeping its policy interest rate at 2.25% for the seventh consecutive meeting.
The last time the Bank made a move was almost a year ago at the end of October 2025 when it lowered the policy rate by 25 basis points.
Inflation is too hot…
Inflation is the Bank of Canada’s preoccupation, and it’s still running too high at 3%—above the 2% target.
The big takeaway from this morning is the Bank’s reference that “inflation pressures have increased,” amid the escalating war in Iran and the U.S.-Canada trade conflict. That reads a touch hawkish to me.
The good news? Underlying inflation (as measured by the Bank’s core inflation metrics) has so far been cooperating. Indeed, core inflation is holding near 2%. According to the Bank, “so far, there has been little evidence of higher energy prices spreading to other components of inflation.”
But the Bank is not resting easy (hence my emphasis on ‘so far’). They are concerned that higher prices at the pumps could become generalized—and if that happens, they may need to lean against those inflationary forces with higher rates.
They also have a new pressure to confront—counter-tariffs, which in our estimation will add 0.2-0.3 percentage points to headline inflation. Providing a temporary assist, reports are circulating that the Government of Canada is expected to announce an extension of its gasoline tax pause for the rest of the year.
…and the economy is too fragile in this ‘fluid’ environment…
The Canadian economy can’t catch a break. Just as it was starting to find its legs, the trade war between Canada and the U.S. entered a new escalating chapter. The Bank calls the situation “fluid” and says that “new tariffs make growth prospects more uncertain.”
Last Friday’s GDP report showed that the economy grew by 3.3% annualized in the second quarter, and upwardly revised the first quarter result from a decline of 0.1% to an increase of 0.3%. That’s better than expected.
The Bank, however, doesn’t appear to be in a celebratory mood. Trade tensions are keeping Bank officials up at night. Or, in the language of the Bank: “uncertainty is high and new U.S. tariffs and threats of further action pose risks to the sustainability of the recovery.”
With all the uncertainty, the Bank was most definitely pleased that the September announcement did not require them to publish a new slate of forecasts. But reading between the lines (and reading ATB’s latest analysis, of course), growth is expected to slow significantly in the third quarter.
Our view is that, if contained to the announced measures, the macro impact of the U.S. tariffs and Canadian counter-tariffs is ‘manageable’, but will disproportionately hit certain sectors and regions. Overall, we think the new tariff measures will shave 0.4-0.5% off real GDP growth, with most of the impact felt in 2027.
The real risk, however, is an escalation of the trade war from here on in.
…keeping the Bank of Canada in a ‘wait-and-see’ pause position
The default position for the Bank in this highly uncertain environment is to stay on the sidelines, carefully track the ever-changing geopolitical situation and be prepared to hike or cut. We think that the Bank will stay on hold for the rest of the year. Our forecast still has two hikes next year, but that is conditional on tariff pressures easing.
In such a ‘fluid’ environment and with an economy still waiting to hit its stride, rate hikes will need to wait.
Even without a BofC rate hike, financial conditions have tightened
According to the Bank, “financial conditions have tightened.” This means that, even without adjustments to the short-term policy rate, the bond market is doing some tightening on its behalf.
Longer-term bond yields have shifted higher in recent weeks, particularly in the U.S. amid fiscal, inflation, and hyperscaler demand pressures. Though not to the same extent, higher longer-term rates have also been felt in Canada.
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