The Bank of canada (BOC) held rates steady at the last meeting, after economists observed that the economy seemed to be improving. But that outlook seems to have changed, as the effects of tariffs sets in. The more recent data seems to match BOC Governor Tiff Macklem’s pessimism about the economy. Now the question is whether that will translate into more interest rate cuts that could weigh on the CAD.
One of the warning signs for the Canadian dollar is its relative weakness under the current circumstances. The spike in crude prices should have piqued interest in Canada’s currency, as it would mean a larger influx of cash to pay for the country’s largest export. However, general confidence in the economy’s outlook seems to have weakened the currency instead. This could mean the market moves to price in more rate cuts this year.
How Long the Pause
The interest rate hold by The Bank of canada (BOC) is clearly understood as a pause in the current rate easing cycle. The consensus among economists is that there will be two more rate cuts this year. They could, in fact, line up with the expectations that the Fed’s cuts in September and December. Normally, keeping the interest rate gap steady would keep the currency pair trading largely steady.
But, there appear to be some problems under the hood of the Canadian economy. One of them appeared in the surprisingly large trade deficit, which saw exports crashing by over 10% compared to a year ago. Macklem highlighted the issue as a sign of potential economic stagnation in an interview earlier this week.
The Inflation Problem
After a couple of years with higher inflation being the problem, The Bank of canada (BOC) could be facing the opposite problem. The conventional wisdom earlier this year when tariffs were first applied was that they’d increase inflation. But, this was based on the traditional view that tariffs would be reciprocated in a trade war.
But Trump’s apply-tariffs-and-take-them-off (or TACO) system has generated considerable uncertainty, with little signs so far of rising inflation in countries targeted with tariffs. Large swaths of the Canadian economy are not subject to tariffs under USMCA rules, and those that have had increased tariffs have led to substitutions. Additionally, Canadian products that are no longer being shipped to the US due to higher tariffs are increasing supply in Canada and driving down prices.
Consumers Resilient Despite Tariffs
Friday sees the release of flash retail sales for May and final retail sales for April. Both are expected to show increases, with the leading sector driving the gains being cars and parts – the exact sector subject to tariffs.
Flash Canadian May retail sales are expected at 0.3%, compared to 0.5% prior. Excluding autos, April retail sales are expected to come in at -0.4% compared to -0.7% prior. The negative reading in “core” retail sales could suggest weakening demand in Canada, a typical precursor of lower inflation.
