As July draws to a close, all eyes in Canada turn to Wednesday, July 30th. It's decision day for the Bank of Canada (BoC), and while the official announcement on the target for the overnight rate will be swiftly delivered, the accompanying Monetary Policy Report (MPR) will offer crucial insights into the central bank's updated economic outlook. This particular decision is steeped in complexity, as the BoC navigates sticky inflation, a softening domestic economy, and perhaps most significantly, the persistent and escalating threat of US-Canada trade tariffs.
The Economic Landscape: A Mixed Picture
Canada's economic picture heading into this decision is, at best, a mixed bag.
Inflation: The headline Consumer Price Index (CPI) has eased, with the latest data for May showing it held steady at 1.7% year-over-year. This is below the BoC's 2% target, partly due to the effects of the federal carbon tax removal and moderating shelter costs. However, the BoC's preferred core measures of inflation (CPI median and trimmed mean) remain elevated, averaging 3.0% in May, indicating that underlying price pressures are still present, particularly in services.
Economic Growth: After a stronger-than-expected Q1 2025 GDP growth of 2.2% (annualized), which was boosted by exports and inventories, the Q2 picture looks considerably weaker. Preliminary estimates for May indicate a 0.1% decline in real GDP, suggesting the Canadian economy is losing momentum as the pre-tariff boost (from "tariff frontrunning") dissipates and other headwinds take hold.
Labour Market: The Canadian labour market showed an unexpected sign of resilience in June, with the unemployment rate edging down to 6.9%. This broke a five-month streak of deterioration and defied some expectations. However, this improvement was largely driven by part-time employment, and long-term unemployment remains elevated, hinting at underlying structural weaknesses. Consumer confidence also remains subdued, with the latest June reading at 48.8 points, indicating continued caution among consumers.
Here's a snapshot of key Canadian economic data:
The Elephant in the Room: US-Canada Trade Negotiations
While the domestic data presents a challenging puzzle, the shadow of US-Canada trade negotiations looms large over the Bank of Canada's decision. US President Donald Trump has reiterated his stance, stating he does not expect a trade deal with Canada before his August 1st deadline, and has threatened "heavy tariffs" if talks fail. The Commerce Secretary has also confirmed the August 1st deadline for new tariffs is "firm."
Existing US tariffs already include a 25% blanket tariff on certain Canadian goods, 50% on aluminum and steel, and 25% on all non-US-built cars and trucks. The new threat includes a potential 35% tariff on a portion of Canadian goods not covered by the existing North American trade pact (USMCA).
How do these trade tensions affect the Bank of Canada's calculus?
Inflationary Pressure vs. Economic Slowdown: This is the BoC's primary dilemma. Tariffs are inherently inflationary, as they raise the cost of imported goods and can lead to higher domestic prices as businesses pass on increased input costs. However, they are also a significant drag on economic growth, as reduced exports and weakened business investment weigh on activity.
The BoC's Q2 Business Outlook Survey and Canadian Survey of Consumer Expectations (referenced in their June MPR) revealed that businesses intend to pass on tariff costs, and consumers expect higher prices.
A significant drop in exports, particularly in the highly integrated auto sector and other trade-intensive industries, could lead to job losses and reduced household income.
Supply Chain Disruptions: The highly integrated supply chains between the two countries mean that tariffs can increase production costs and prices for a wide range of goods that cross the border multiple times as intermediate inputs.
Uncertainty: The ongoing uncertainty itself is a negative economic factor, leading businesses to postpone investment and hiring decisions, and making consumers more cautious about spending.
The Bank of Canada's Tightrope Walk
The Bank of Canada faces a delicate balancing act. On one hand, persistent core inflation and the potential for tariffs to push up prices further argue against a rate cut. On the other hand, weakening economic growth, the potential for significant job losses from trade disruptions, and slowing consumer spending argue for easing monetary policy.
Most economists anticipate the BoC will hold the policy interest rate at 2.75% at the July 30th meeting. The prevailing sentiment is that the central bank will want to observe the actual impact of any new tariffs and gauge how trade negotiations evolve before making a significant move. A hold would allow them to gather more data and assess the severity and duration of the trade conflict's impact on both inflation and growth.
However, the updated Monetary Policy Report will be scoured for clues. Any changes to their inflation and GDP forecasts, particularly factoring in the trade risks, will signal the Bank's leanings for future decisions. If the trade situation deteriorates significantly and the economic fallout is more severe than anticipated, the door to rate cuts later in the year (e.g., September or beyond) could open wider, despite the inflationary pressures from tariffs. Conversely, if a resolution is reached or the impact is milder, the BoC might remain on a more cautious path.
What Does This Mean for You?
For Canadians, this complex economic environment translates into continued uncertainty.
Borrowing Costs: The Canadian Prime Rate remains at 4.95%, directly influenced by the Bank of Canada's policy rate. This means stability for variable-rate mortgages, lines of credit, and other prime-linked loans for now. However, the future trajectory will depend heavily on the trade situation.
Inflation and Prices: The threat of tariffs means that despite some moderating in headline CPI, consumers should be prepared for potential price increases on a range of goods, especially if tariffs are broad-based and sustained.
Job Market: While the June employment numbers offered a glimmer of hope, the underlying fragility, especially from trade disruptions, suggests the job market could face headwinds in the coming months.
Housing Market: Already showing signs of softening, the housing market could continue to see slower activity if economic uncertainty persists and affordability remains a challenge. The RBC Housing Affordability Index (59.5% in Q2 2024) continues to highlight significant challenges for homebuyers.
The Bank of Canada's July 30th announcement will be more than just a rate decision; it will be a crucial assessment of Canada's economic resilience in the face of domestic challenges and escalating global trade tensions. How the BoC communicates its outlook on these intertwined factors will provide vital guidance for businesses and households navigating an uncertain economic landscape.
