With Tariffs Looming, BoC Stays on Hold and Watches Inflation

On June 4, the Bank of Canada (BoC) announced that it would maintain its target for the overnight rate at 2.75%, with the Bank Rate at 3.00% and the deposit rate at 2.70%. This decision aligned with market expectations, given the persistent uncertainty tied to global trade tensions. The ongoing tariff volatility, primarily driven by the United States’ shifting trade policies with China, Europe, and Canada, continues to cloud the outlook for growth and inflation, indirectly pressuring the Canadian economy.

Canada’s economic performance in the first quarter of 2025 came in slightly stronger than the Bank had projected, with GDP growing at an annualized rate of 2.2%. This resilience, however, was largely attributed to economic activity that was brought forward in anticipation of rising tariffs. The underlying strength in business investment, particularly in machinery and equipment, also exceeded expectations. That said, signs of strain are becoming more apparent: household consumption slowed, housing activity contracted sharply, and government spending declined. Most notably, labour market conditions weakened, especially in trade-sensitive sectors, lifting the unemployment rate to 6.9% in April, up from 6.7% previously. On the inflation front, CPI fell to 1.7% in April, but this was primarily due to the removal of the consumer carbon tax. Adjusted for this factor, inflation remained steady at 2.3%, marginally above BoC projections. Surveys suggest that both households and businesses expect continued upward price pressure due to tariffs, with many firms planning to pass cost increases on to consumers.

Source: Statistics Canada - Consumer Price Index, April 2025

The global trade environment remains a major source of economic uncertainty. The 90-day pause on new US tariffs, agreed upon in early April, is scheduled to expire in early July. While some progress has been made, such as renewed bilateral negotiations between the US and China and initial dialogues with European partners, tariff rates remain significantly above their early-2025 levels. The threat of further trade actions persists. In the US, domestic demand is still relatively firm, though overall Q1 GDP was pulled lower by a surge in imports. Meanwhile, China’s economic momentum has cooled as previous stimulus measures wane, and the weight of existing tariffs begins to curb exports. In Europe, growth has been bolstered by strong external demand and rising defense expenditures. The uncertain trajectory of these major economies, and their trade links to Canada, contributes to the difficulty in forecasting near-term domestic performance.

Canadian Exports in 2024 - Source: OEC

Looking ahead, the Bank of Canada emphasized its data-dependent stance. Policymakers are monitoring how much tariff-related cost pressures flow through to consumers, how they affect inflation expectations, and the extent to which softer export demand impacts business investment and household spending. The next BoC policy announcement is scheduled for July 30th. As of today, markets are assigning a 56.9% probability to a rate cut at that meeting, reflecting increased downside risks but also the BoC’s cautious tone. In the US, the Federal Reserve’s next meeting is set for June 18th, with a 96.7% probability that rates will remain unchanged. Both central banks are trying to balance the need to support growth with the need of maintaining inflation control in a turbulent global setting.

World Interest Rate Probability - Source: Bloomberg - June 4, 2025

World Interest Rate Probability - Source: Bloomberg - June 4, 2025

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