The central bank of Canada is sitting down to a very difficult decision about what to do with rates. The markets seem pretty convinced that they will go for a quarter point cut, like the last sic times. If that were the case, then the markets will look past the rate decision to try to figure out what comes next.
But some analysts fret that the BOC is facing a particularly challenging environment that it could make a choice that would surprise traders. The potential impact of tariffs are seen as inflationary, and with the core rate elevated, that might be a reason for the BOC to hold off on another cut. On the other hand, the potential economic drag of the tariffs could mean that the BOC could take a stronger hand in helping boost activity, by sending a “clear signal” to the markets. That could be interpreted as a 50 bps cut, or a quarter point now with strong language suggesting further easing is coming.
The Trade War Has Multiple Effects
The relationship between Canada and its largest trade partner (77% of Canada’s exports go to the US) has been strained by the application of tariffs by the Trump Administration. But on top of that is the “joking” or “meming” of Canada becoming the 51st state. This has riled up Canadians, pushing for changes beyond the merely transactional in terms of trade.
Now Former Prime Minister Justin Trudeau has handed the baton off to the new Prime Minister and former BOC Governor Mark Carney. There has been a strong move in Canada to address the country’s ailing economy, which could get further support from a business-friendly leader taking the reins. Businesses have long fretted about “microregulations” that have made trade within the country difficult. The “situation” with the US now has motivated a change in attitude in Ottawa towards boosting the economy as it faces down the potential impact of Trump’s tariffs.
But, What About Inflation?
Headline inflation in Canada has been hovering around the middle of the 1.0-3.0% target range, but the core rate has been around the top part of that segment. The unemployment rate is relatively high at 6.6% last reported. This provides an awkward position for the central bank. If it keeps a hawkish stance, it could further damage the fledgling economic recovery. If it eases, then the core CPI rate could easily escape the target range.
Governor Macklem has warned that politicians shouldn’t rely on the BOC to fix the situation. Which could be interpreted as a way of him saying that the bank will take the more cautious, middle of the road approach. This might disappoint traders, as the market has already priced in a cautious, downward slope for the interest rate, and therefore the Canadian dollar.
What to Look Out For
The trade war creates the risk that the Loonie could fall substantially and the economy could severely underperform. That would mean that to deal with tariffs, the BOC might be forced to keep easing. So, if the accompanying statement to the rate decision puts emphasis on the economy, and worries about the effect of the trade war, then traders might take that as a sign of more easing.
On the other hand, if the emphasis is on inflation and the employment situation, then the market could interpret a rate cut as “hawkish”. Even keeping to the rhetoric used by the BOC before the trade war could be seen as taking a hawkish bent.
