Key Takeaways
- The Bank of Canada will likely keep interest rates steady at its June 10 meeting, analysts say.
- The economy saw a surprise first-quarter slowdown, then big job gains in May against a backdrop of energy-fueled inflation.
- An interest rate cut is more likely as the central bank’s next move than a hike, analysts say, but the bond market continues to price in an increase later this year.
A surprise economic downturn in the first quarter has reshaped the debate around interest rates at the Bank of Canada, even as it is seen holding interest rates steady at its Wednesday meeting. Economists say a rate cut is back on the table, though the bond market is still pricing a hike later this year.
For now, economists say the backdrop suggests central bank officials will leave the key policy rate at 2.25%, where it has been since December. Policymakers are meeting for the fourth time this year on June 10 amid mixed economic news, higher energy inflation due to the Iran war, and ongoing uncertainty around trade talks with the United States.
“We believe the Bank will be on hold in June, and likely so for the remainder of the year,” says Douglas Porter, chief economist at BMO Economics. “In fact, if oil continues to recede, we believe the case for rate cuts could build over the next year.” He points to a range of factors, including economic contraction, cooling core inflation, and a sluggish labor market, all of which he believes rule out any possibility of a rate hike. As his base case, Porter expects rates to remain unchanged through 2027, and he says that “market pricing of rate increases is offside.”
Views are largely aligned that the Bank will not raise rates, despite Friday’s May employment data and an unexpected first-quarter decline in gross domestic product, marking two consecutive quarters of economic contraction.
The latest labor market data showed a blowout gain of 88,000 jobs in May, a rebound from 18,000 losses the prior month. The unemployment rate fell to 6.6% from 6.9% in April. “They were good numbers, but the monthly data have a lot of random noise, given the sample size for the survey, and it’s far too soon to call this a turning point,” says Avery Shenfeld, senior economist at CIBC Economics.
The Economy Looks Too Weak for a Rate Hike This Year, Analysts Say
The Bank will remain in a holding pattern as it balances weaker economic activity and higher inflation linked to the Iran war, according to a Goldman Sachs analyst note to investors. Despite Canada entering a technical recession in the first quarter with a second consecutive quarter of negative GDP growth, as well as continued cooling in core inflation (which excludes food and energy prices), “signs of activity improvement and continued concerns around energy prices and inflation expectations will likely keep the Bank of Canada on hold.”
Beyond Wednesday’s expected hold, analysts are increasingly leaning toward the possibility of interest rates dipping lower rather than ticking higher. “Rates are clearly neutral and still flowing through into consumption through the mortgage market,” says Jack Manley, global market strategist at JP Morgan Asset Management. The neutral rate is a theoretical marker at which monetary policy neither stimulates nor restricts the economy. “The Bank can be patient and wait a bit longer, and if it does decide there’s a problem, I believe the bias remains toward cutting rather than hiking.”
Elevated inflation may be the only factor preventing policymakers from cutting rates, says National Bank Capital Markets rates strategist Taylor Schleich. However, “rate cuts may be appropriate later this year if the conflict de-escalates and oil prices retreat more forcefully, economic data remain weak and/or the trade uncertainty damages consumer and business confidence again,” he says.
Having experienced back-to-back quarters of contraction, the economy remains too weak to justify a rate hike, according to CIBC’s Shenfeld. He expects that situation to persist at least until next year, given higher energy prices linked to the Iran war. But that outlook could change if Canada gets an unfavorable trade deal with the US.
“While our forecast doesn’t include a rate cut, that would be the most likely move in 2026 if we saw negative developments in Canada-US trade talks,” Shenfeld says. “For now, our forecast includes no change in rates right through the first quarter of 2027.”
What Could Trigger a Rate Hike?
While the odds of a rate hike have receded since March, when markets were pricing in three hikes by year-end, analysts say persistently higher energy prices from the Iran war could strengthen the case for tighter monetary policy. ”The decision to hike would be made quicker and easier if we started to see strengthening economic activity,” says National Bank’s Schleich, who’s also looking for signs of higher energy prices spilling over to other goods and services.
To that effect, Bank of Canada Governor Tiff Macklem stressed in April that while the Bank would be “looking through the war’s immediate impact on inflation,” if it spills into the broader economy, “there may be a need for consecutive increases in the policy rate.”
Focus Turns to the Bank of Canada’s Guidance
With the economy having recorded two consecutive quarters of GDP contraction—the technical definition of a recession—markets will be paying close attention to any change in tone in the Bank’s announcement on Wednesday.
Even so, analysts expect policymakers to offer little new guidance. Goldman Sachs’s economists wrote that they “expect limited changes to the guidance. The statement will likely acknowledge that economic data remains weak and reiterate that the BoC is looking through the temporary energy price shock, but continue to emphasize that the BoC remains ‘ready to respond as needed’ if inflation pressures become persistent.”
National Bank’s Schleich is looking for officials to signal concerns about the potential inflation to head higher, “and will probably continue to flag that rate hikes are a genuine possibility.”
The Bank is likely to maintain that it is “being cautious but flexible with future decisions,” says Claire Fan, senior economist at Royal Bank of Canada.
