Bank of Canada Holds at 2.25% and Warns of Policy ‘Dilemma’

Tiff Macklem, right, and Carolyn Rogers during a news conference in Ottawa, Ontario, Canada, in April. Photographer: David Kawai/Bloomberg Photo by David Kawai /Bloomberg

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(Bloomberg) — The Bank of Canada held its key interest rate but reiterated that US trade uncertainty and the Iran war may mean it needs to either cut or deliver consecutive hikes to keep inflation stable.

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The central bank maintained its policy rate at 2.25% on Wednesday for a fifth consecutive time, matching expectations of markets and forecasters, as the economy remains weak and the global oil shock drives up inflation.

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“Economic weakness combined with rising inflation is a dilemma for monetary policy. Raising rates to dampen inflation could further slow the economy. Easing rates to support growth increases the risk that higher inflation becomes persistent,” Governor Tiff Macklem said in prepared remarks.

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“For now, holding the policy rate unchanged balances those risks.”

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However, Macklem said monetary policy needs to be “nimble” as uncertainty remains elevated. He repeated language from the April decision on the potential need to cut the policy rate to support growth if the US imposes “significant new trade restrictions.”

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“Alternatively, if the conflict in the Middle East continues and higher energy prices start leading to ongoing generalized inflation, monetary policy will have more work to do — there may be a need for consecutive increases in the policy rate,” Macklem said.

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The loonie was stronger on Wednesday, holding steady after the decision. It advanced 0.2% on the day, trading at C$1.3925 per US dollar as of 10:21 a.m. in Ottawa. Canadian two-year government bond yields were down about two basis points to 2.827%.

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“By retaining the word ‘consecutive’ for hikes in a possible high oil price and generalized inflation scenario, the bank continued to play into market expectations that the magnitude of risks is not symmetric,” Andrew Grantham, senior economist at Canadian Imperial Bank of Commerce, said in a report to investors.

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“Overall, however, we view today’s communication as highlighting a very patient central bank that has plenty of time to wait and see how risks to the economy play out.”

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The central bank noted there has been limited evidence of broad-based pass-through of higher energy prices to other prices. However, the governor said oil prices have remained elevated as the Iran war persists, and the price of a barrel is roughly $10 higher than the central bank assumed in its April monetary policy report.

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“Based on this, we expect CPI inflation to hover close to 3% in coming months before easing gradually toward 2%,” Macklem said.

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Canada’s inflation rate reached 2.8% in April amid higher energy prices, but was still lower than economists had anticipated. Core measures of inflation also eased that month, suggesting underlying price pressures remain under control.