Bank of Canada in a ‘tough spot’ as higher oil prices, weakening economy pull it in opposing directions

The Bank of Canada building in Ottawa. Photo by HYUNGCHEOL PARK/Postmedia files

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There are too many unknowns for the Bank of Canada to hint at where it might take interest rates if the conditions call for a change in monetary policy, say economists, after policymakers on Wednesday held rates at 2.25 per cent for the third straight time.

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Among the unknowns are how long the war in Iran could last, the effects of the oil-price shock on the Canadian economy and the looming review of the Canada-United States-Mexico Agreement (CUSMA).

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Here’s what economists think of the latest rate decision and where the Bank of Canada goes from here.

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‘Opposing forces’: Desjardins

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“The Bank of Canada is caught between two opposing forces: surging global energy prices and a weakening domestic economy,” Royce Mendes, managing director and head of macro strategy at Desjardins Group, said in a note.

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Energy prices have risen around 40 per cent since the start of the U.S.-Israel-led attack on Iran, while Canada’s first-quarter gross domestic product (GDP) could significantly undershoot the Bank of Canada’s estimate for annualized growth of 1.8 per cent.

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However, Mendez said policymakers took the threats posed by the deteriorating job market, souring business conditions and additional financial stress of higher energy prices on households over the risks that elevated oil prices pose to inflation.

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The Bank of Canada also removed the line in its statement that the current level of interest rates looked “appropriate,” but Mendes said that doesn’t indicate any imminent rate hikes.

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“The tone of these communications reinforces our view that the Bank of Canada is willing to look through the impacts of higher energy prices on (the consumer price index) so long as the conflict doesn’t last for too long,” he said.

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Desjardins expects the Bank of Canada to keep interest rates at their current level for the rest of the year.

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‘Doves and hawks’: BMO

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There was “a little bit of something for both the doves and the hawks” in the Bank of Canada’s latest interest rate decision, Douglas Porter, chief economist at BMO Economics, said in a note, pointing out that governor Tiff Macklem referenced the weak state of the economy and the inflation threat posed by higher energy prices.

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But he said the doves — those calling for rate cuts rather than hikes — won out.

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“The quick takeaway is that the (Bank of Canada) can afford to be patient over the near term,” he said, referring to Macklem’s comments that the effects of the Iran war look “contained” for now.

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Still, Porter said it was important to acknowledge that Macklem said that if energy prices stay high, the Bank of Canada would not let the effects “broaden and become persistent inflation.”

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Markets are betting for a rate hike by year-end, but he said the case for that call is “weak,” especially because of the continuing uncertainty around trade talks with the U.S.