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Bank Stays the Course as Trade Policy Clouds the Road Ahead

Canadian Economics

By: Walter Bolduc

    

  • The Bank of Canada left the overnight rate unchanged at 2.75 per cent with the Bank Rate at 3.00 per cent and the deposit rate at 2.70 per cent, citing a fragile balance between weakening domestic demand and lingering inflationary pressures tied to trade disruptions.
  • The Bank’s Monetary Policy Report in July replaces standard projections with three tariff-based scenarios (status quo, escalation, de-escalation), reflecting high U.S. trade policy uncertainty.
  • The Canadian economy likely contracted 1.5 per cent in Q2 after strong export activity in the first quarter pulled forward demand. Labour market weakness is concentrated in trade-exposed sectors, with the unemployment rate rising to 6.9 per cent in June.
  • Headline CPI was 1.9 per cent last month, but inflation excluding the removal of the consumer carbon price in April hit 2.5 per cent, driven by non-energy goods. Meanwhile, shelter inflation remains high but is easing, and underlying inflation remains around 2.5 per cent.
  • While global growth remains near 2.5 per cent for 2025, U.S. consumer pricing dynamics are starting to reflect tariff costs, and the Euro area and Chinese economic growth patterns are diverging.
  • Intuitively, higher tariffs could push inflation upward, while lower tariffs could ease price pressure. Businesses face rising costs from sourcing shifts, which could spill over into consumer prices.
  • The Bank emphasized it is “proceeding carefully,” monitoring the impact of tariffs on investment, hiring, and consumer spending. A rate cut remains possible in future announcements if downward inflationary pressures surpass the inflationary effects of trade-related price increases.

Insights

Surprising Strength. Despite the elevated trade uncertainty under the new U.S. administration, the impact on Canada’s economy has been mixed. Statistics Canada’s latest labour force survey was a surprise to most, with the Canadian economy adding 83,000 jobs in June, the bulk of which were in wholesale and retail trade. Although the increase was largely part-time employment gains, June’s gain was the first increase since January and indicates that Canada’s economy may be running hotter than expected. The resilience of the labour market, paired with June’s uptick in inflation to 1.9 per cent (up from 1.7 per cent in May) ultimately encouraged the Bank to hold off on any rate cuts as it assesses the near-term developments in the Canada-U.S. trade relationship.

The full impact of Canada’s retaliatory tariffs hasn’t completely matured yet. With many firms operating on a first-in-first-out accounting basis, the influence of tariffs on inflation has been delayed while firms deplete cheaper pre-tariff inventory. Once this stock is gone, firms’ product prices will begin to reflect the elevated costs they face from tariffed imports, accelerating inflation. That said, with the U.S. applying blanket tariffs on its trading partners, the global economy is in for turbulence and slower global economic activity is anticipated, which could offset some of these inflationary pressures. Another factor which could influence inflationary pressures stems from weak business sentiment, driven by the constantly evolving trade policies of the new U.S. administration. As firms remain concerned about market demand, they are more likely to absorb the additional costs from tariffs, rather than raise prices to consumers, a finding observed in our latest Index of Business Confidence.

To learn more about how Canadian businesses are reacting to the rapidly changing global landscape, see our latest research and analysis in the Index of Business Confidence series.

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